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 2018 EDITION

TAXATION of INDIVIDUALS AND

McGraw-Hill’s

BUSINESS ENTITIES
SPILKER • AYERS • BARRICK • OUTSLAY • ROBINSON • WEAVER • WORSHAM
 McGraw-Hill’s

Taxation of Individuals
and Business Entities
Brian C. Spilker
Brigham Young University
Editor

Benjamin C. Ayers John A. Barrick

The University of Georgia Brigham Young University
Edmund Outslay John R. Robinson
Michigan State University Texas A&M University
Connie D. Weaver Ron G. Worsham
Texas A&M University Brigham Young University
McGRAW-HILL’S TAXATION OF INDIVIDUALS AND BUSINESS ENTITIES, 2018 EDITION, NINTH EDITION
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Dedications
We dedicate this book to:
My entire family, whose love and support helped make this book possible, and to Professor Dave Stewart for his
great example and friendship over the last three decades.
Brian Spilker
My wife, Marilyn, daughters Margaret Lindley and Georgia, son Benjamin, and parents Bill and Linda.
Ben Ayers
My wife, Jill, and my children Annika, Corinne, Lina, Mitch, and Connor.
John Barrick
My family, Jane, Mark, Sarah, Chloe, Lily, Jeff, and Nicole, and to Professor James E. Wheeler, my mentor and friend.
Ed Outslay
JES, Tommy, and Laura.
John Robinson
My family: Dan, Travis, Alix, and Alan, and to Professor Dave Stewart.
Connie Weaver
My wife, Anne, sons Matthew and Daniel, and daughters Whitney and Hayley.
Ron Worsham
 About the Authors

Brian Spilker (PhD, University of Texas at Austin, 1993) is the Robert Call/Deloitte Professor
in the School of Accountancy at Brigham Young University. He teaches taxation in the grad-
uate and undergraduate programs at Brigham Young University. He received both BS (Summa
Cum Laude) and MAcc (tax emphasis) degrees from Brigham Young University before work-
ing as a tax consultant for Arthur Young & Co. (now Ernst & Young). After his professional
work experience, Brian earned his PhD at the University of Texas at Austin. In 1996, he was
selected as one of two nationwide recipients of the Price Waterhouse Fellowship in Tax
Award. In 1998, he was a winner of the American Taxation Association and Arthur Andersen
Teaching Innovation Award for his work in the classroom; he has also been awarded for his
use of technology in the classroom at Brigham Young University. Brian researches issues re-
lating to tax information search and professional tax judgment. His research has been pub-
Courtesy of Brian Spilker
lished in journals such as The Accounting Review, Organizational Behavior and Human
Decision Processes, Journal of the American Taxation Association, Behavioral Research in
Accounting, Journal of Accounting Education, Journal of Corporate Taxation, and Journal of
Accountancy.

Ben Ayers (PhD, University of Texas at Austin, 1996) holds the Earl Davis Chair in Taxation
and is the dean of the Terry College of Business at the University of Georgia. He received a
PhD from the University of Texas at Austin and an MTA and BS from the University of
­Alabama. Prior to entering the PhD program at the University of Texas, Ben was a tax
­manager at KPMG in Tampa, Florida, and a contract manager with Complete Health, Inc., in
Birmingham, Alabama.

Ben teaches tax planning and research courses in the undergraduate and graduate programs at
the University of Georgia. He is the recipient of 11 teaching awards at the school, college, and
university levels, including the Richard B. Russell Undergraduate Teaching Award, the high-
est teaching honor for University of Georgia junior faculty members. His research interests
Courtesy Ben Ayers
include the effects of taxation on firm structure, mergers and acquisitions, and capital markets
and the effects of accounting information on security returns. He has published articles in
journals such as The Accounting Review, Journal of Finance, Journal of Accounting and Eco-
nomics, Contemporary Accounting Research, Review of Accounting Studies, Journal of Law
and Economics, Journal of the American Taxation Association, and National Tax Journal.
Ben was the 1997 recipient of the American Accounting Association’s Competitive Manu-
script Award, the 2003 and 2008 recipient of the American Taxation Association’s Outstand-
ing Manuscript Award, and the 2016 recipient of the American Taxation Association’s Ray
M. Sommerfeld Outstanding Tax Educator Award.

iii
iv About the Authors

John Barrick (PhD, University of Nebraska at Lincoln, 1998) is currently an associate profes-
sor in the Marriott School at Brigham Young University. He served as an accountant at the
United States Congress Joint Committee on Taxation during the 110th and 111th Congresses.
He teaches taxation in the graduate and undergraduate programs at Brigham Young Univer-
sity. He received both BS and MAcc (tax emphasis) degrees from Brigham Young University
before working as a tax consultant for Price Waterhouse (now PricewaterhouseCoopers).
­After his professional work experience, John earned his PhD at the University of Nebraska at
Lincoln. He was the 1998 recipient of the American Accounting Association, Accounting,
Behavior, and Organization Section’s Outstanding Dissertation Award. John researches issues
relating to tax corporate political activity. His research has been published in journals such as
Organizational Behavior and Human Decision Processes, Contemporary Accounting
Courtesy John Barrick
­Research, and Journal of the American Taxation Association.

Ed Outslay (PhD, University of Michigan, 1981) is a professor of accounting and the Deloitte/
Michael Licata Endowed Professor of Taxation in the Department of Accounting and Infor-
mation Systems at Michigan State University, where he has taught since 1981. He received a
BA from Furman University in 1974 and an MBA and PhD from the University of Michigan
in 1977 and 1981. Ed currently teaches graduate classes in corporate taxation, multiunit enter-
prises, accounting for income taxes, and international taxation. In February 2003, Ed testified
before the Senate Finance Committee on the Joint Committee on Taxation’s Report on Enron
Corporation. MSU has honored Ed with the Presidential Award for Outstanding Community
Service, Distinguished Faculty Award, John D. Withrow Teacher-Scholar Award, Roland H.
Salmonson Outstanding Teaching Award, Senior Class Council Distinguished Faculty Award,
MSU Teacher-Scholar Award, and MSU’s 1st Annual Curricular Service-Learning and Civic
Engagement Award in 2008. Ed received the Ray M. Sommerfeld Outstanding Tax Educator
Courtesy Ed Outslay
Award in 2004 and the Lifetime Service Award in 2013 from the American Taxation Associ-
ation. He has also received the ATA Outstanding Manuscript Award twice, the ATA/Deloitte
Teaching Innovations Award, and the 2004 Distinguished Achievement in Accounting Educa-
tion Award from the Michigan Association of CPAs. Ed has been recognized for his commu-
nity service by the Greater Lansing Chapter of the Association of Government Accountants,
the City of East Lansing (Crystal Award), and the East Lansing Education Foundation. He
received a National Assistant Coach of the Year Award in 2003 from AFLAC and was named
an Assistant High School Baseball Coach of the Year in 2002 by the Michigan High School
Baseball Coaches Association.
 About the Authors v

John Robinson (PhD, University of Michigan, 1981) is the Patricia ’77 and Grant E. Sims ’77
Eminent Scholar Chair in Business. Prior to joining the faculty at Texas A&M, John was the
C. Aubrey Smith Professor of Accounting at the University of Texas at Austin, Texas, and he
taught at the University of Kansas where he was the Arthur Young Faculty Scholar. In
2009–2010 John served as the Academic Fellow in the Division of Corporation Finance at the
Securities and Exchange Commission. He has been the recipient of the Henry A. Bubb Award
for outstanding teaching, the Texas Blazer’s Faculty Excellence Award, and the MPA Council
Outstanding Professor Award. John also received the 2012 Outstanding Service Award from
the American Taxation Association (ATA). John served as the 2014–2015 president (elect) of
the ATA and is the ATA’s president for 2015–2016. John conducts research in a broad variety
of topics involving financial accounting, mergers and acquisitions, and the influence of taxes
on financial structures and performance. His scholarly articles have appeared in The Account-
ing Review, The Journal of Accounting and Economics, Journal of Finance, National Tax Courtesy John Robinson
Journal, Journal of Law and Economics, Journal of the American Taxation Association, The
Journal of the American Bar Association, and The Journal of Taxation. John’s research was
honored with the 2003 and 2008 ATA Outstanding Manuscript Awards. In addition, John was
the editor of The Journal of the American Taxation Association from 2002–2005. Professor
Robinson received his J.D. (Cum Laude) from the University of Michigan in 1979, and he
earned a PhD in accounting from the University of Michigan in 1981. John teaches courses on
individual and corporate taxation and advanced accounting.

Connie Weaver (PhD, Arizona State University, 1997) is the KPMG Professor of Accounting
at Texas A&M University. She received a PhD from Arizona State University, an MPA from
the University of Texas at Arlington, and a BS (chemical engineering) from the University of
Texas at Austin. Prior to entering the PhD Program, Connie was a tax manager at Ernst &
Young in Dallas, Texas, where she became licensed to practice as a CPA. She teaches taxation
in the Professional Program in Accounting and the Executive MBA program at Texas A&M
University. She has also taught undergraduate and graduate students at the University of Wis-
consin–Madison and the University of Texas at Austin. She is the recipient of several teaching
awards, including the 2006 American Taxation Association/Deloitte Teaching Innovations
award, the David and Denise Baggett Teaching award, and the college level Association of
Former Students Distinguished Achievement award recognizing innovation in teaching taxa-
Courtesy Connie Weaver
tion. Connie’s current research interests include the effects of tax and financial incentives on
corporate decisions and reporting. She has published articles in journals such as The Account-
ing Review, Contemporary Accounting Research, Journal of the American Taxation Associa-
tion, National Tax Journal, Accounting Horizons, Journal of Corporate Finance, and Tax
Notes. She serves on the editorial board of Contemporary Accounting Research and Issues in
Accounting Education and was the 1998 recipient of the American Taxation Association’s
Outstanding Dissertation award.

Ron Worsham (PhD, University of Florida, 1994) is an associate professor in the School of
Accountancy at Brigham Young University. He teaches taxation in the graduate, undergradu-
ate, MBA, and Executive MBA programs at Brigham Young University. He has also taught as
a visiting professor at the University of Chicago. He received both BS and MAcc (tax empha-
sis) degrees from Brigham Young University before working as a tax consultant for Arthur
Young & Co. (now Ernst & Young) in Dallas, Texas. While in Texas, he became licensed to
practice as a CPA. After his professional work experience, Ron earned his PhD at the Univer-
sity of Florida. He has been honored for outstanding innovation in the classroom at Brigham
Young University. Ron has published academic research in the areas of taxpayer compliance
and professional tax judgment. He has also published legal research in a variety of areas. His
work has been published in journals such as Journal of the American Taxation Association,
The Journal of International Taxation, The Tax Executive, Tax Notes, The Journal of Account- Courtesy Ron Worsham
ancy, and Practical Tax Strategies.
TEACHING THE CODE IN CONTEXT

The basic approach to teaching taxation hasn’t changed in decades. Today’s

student deserves a new approach. McGraw-Hill’s Taxation of Individuals
and Business Entities is a bold and innovative series that has been adopted
by over 300 schools across the country.
McGraw-Hill’s Taxation is designed to provide
“This is the best tax book on the market. It’s very
a unique, innovative, and engaging learning ex-
readable, student-friendly, and provides great
perience for students studying taxation. The
supplements.”
breadth of the topical coverage, the storyline
approach to presenting the material, the em- – Ann Esarco,
phasis on the tax and nontax consequences of McHenry County College
multiple parties involved in transactions, and
the integration of financial and tax accounting
topics make this book ideal for the modern tax
curriculum.

Since the first manuscript was written in

“A lot of thought and planning went into the struc-
ture and content of the text, and a great product
was achieved. One of the most unique and help-
ful features is the common storyline throughout
each chapter.”
– Raymond J. Shaffer,
Youngstown State University
2005, 437 professors have contributed 478
book reviews, in addition to 26 focus groups
and symposia. Throughout this preface, their
comments on the book’s organization, peda-
gogy, and unique features are a testament to
the market-driven nature of Taxation’s
development.

“The Spilker text, in many ways, is a more logical approach than any other tax textbook. The text makes
great use of the latest learning technologies through Connect and LearnSmart.”
– Ray Rodriguez, Southern Illinois University–Carbondale

vi
A MODERN APPROACH
FOR TODAY’S STUDENT
“This text provides a new approach to the teaching of the technical material. The style of the text material
is easier to read and understand. The examples and storyline are interesting and informative. The arrangement
makes more sense in the understanding of related topics.”
– Robert Bertucelli, Long Island University–Post

Spilker’s taxation series was built around the following five core precepts:

1
Storyline Approach: Each chapter begins with a storyline that introduces a set of characters or
a business entity facing specific tax-related situations. Each chapter’s examples are related to
the storyline, providing students with opportunities to learn the code in context.

2
Integrated Examples: In addition to provid-
ing examples in-context, we provide
“What if ” scenarios within many examples
to illustrate how variations in the facts
might or might not change the answers.
“Excellent text; love the story line approach and
integrated examples. It’s easy to read and under-
stand explanations. The language of the text is very
clear and straightforward.”
– Sandra Owen, Indiana University–Bloomington

3
Conversational Writing Style: The authors took special care to write McGraw-Hill’s Taxation in
a way that fosters a friendly dialogue between the content and each individual student. The
tone of the presentation is intentionally conversational—creating the impression of speaking
with the student, as opposed to lecturing to the student.
4
Superior Organization of Related Topics:
McGraw-Hill’s Taxation provides two al- “I believe it breaks down complex topics in a way
that’s easy to understand. Definitely easier than
ternative topic sequences. In the McGraw-
other tax textbooks that I’ve had experience with.”
Hill’s Taxation of Individuals and Business
Entities volume, the individual topics gen- – Jacob Gatlin, Athens State University
erally follow the tax form sequence, with
an individual overview chapter and then chapters on income, deductions, investment-related
issues, and the tax liability computation. The topics then transition into business-related topics
that apply to individuals. This volume then provides a group of specialty chapters dealing with
topics of particular interest to individuals (including students), including separate chapters on
home ownership, compensation, and retirement savings and deferred compensation. This volume
concludes with a chapter covering the taxation of business entities. Alternatively, in the
­Essentials of Federal Taxation volume, the topics follow a more traditional sequence, with
­topics streamlined (no specialty chapters) and presented in more of a life-cycle approach.

5
Real-World Focus: Students learn best when they see how concepts are applied in the real world.
For that reason, real-world examples and articles are included in “Taxes in the Real World”
boxes throughout the book. These vignettes demonstrate current issues in taxation and show
the relevance of tax issues in all areas of business.
vii
 ®

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Connect require it; instructor Using Connect improves retention
rates by 19.8%, passing rates by
satisfaction increases by 28% when 12.7%, and exam scores by 9.1%.
Connect is required.

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Connect Insight is Connect’s new one-
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Connect Insight gives the user the ability to
take a just-in-time approach to teaching and
learning, which was never before available.
Connect Insight presents data that helps
instructors improve class performance in a
way that is efficient and effective.
Adaptive
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SmartBook®
Proven to help students improve grades and
study more efficiently, SmartBook contains the
same content within the print book, but actively
tailors that content to the needs of the individual.
SmartBook’s adaptive technology provides precise,
personalized instruction on what the student
should do next, guiding the student to master
and remember key concepts, targeting gaps in
knowledge and offering customized feedback,
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ONLINE ASSIGNMENTS
Connect helps students learn more effi-
ciently by providing feedback and practice
material when they need it, where they
need it. Connect grades homework auto-
matically and gives immediate feedback
on any questions students may have
missed. The extensive assignable, gradable
end-of-chapter content includes a general
journal application that looks and feels
more like what you would find in a general
ledger software package. Also, select ques-
tions have been redesigned to test students’
knowledge more fully. They now include
tables for students to work through rather than requiring that all calculations be done offline.

End-of-chapter questions in Connect include:

∙ Discussion Questions
∙ Problems
∙ Comprehensive Problems (Available in the Auto-graded Tax Forms!)

Auto-Graded Tax Forms

The auto-graded Tax Forms in Connect provide a much-improved student experience when
­solving the tax-form based problems. The tax form simulation allows students to apply tax con-
cepts by completing the actual tax forms online with automatic feedback and grading for both
students and instructors.

x
Guided Examples
The Guided Examples in Connect provide a narrated, animated, step-by-step walk-through of select
problems similar to those assigned. These short presentations can be turned on or off by instructors
and provide reinforcement when students need it most.

McGraw-Hill Customer Experience Group Contact Information

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why our services don’t stop after you purchase our products. You can contact our Product Specialists 24
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TaxACT®
McGraw-Hill’s Taxation can be packaged with tax software from TaxACT, one of the
leading preparation software companies in the market today. The 2017 edition in-
cludes availability of both Individuals and Business Entities software, including the 1040 Forms and
TaxACT Preparer’s Business 3-Pack (with Forms 1065, 1120, and 1120S).
Roger’s CPA
McGraw-Hill Education has partnered with Roger CPA Review, a global leader
in CPA Exam preparation, to provide students a smooth transition from the ac-
counting classroom to successful completion of the CPA Exam. While many aspiring accountants wait until they
have completed their academic studies to begin preparing for the CPA Exam, research shows that those who be-
come familiar with exam content earlier in the process have a stronger chance of successfully passing the CPA
Exam. Accordingly, students using these McGraw-Hill materials will have access to sample CPA Exam Multiple-
Choice questions and Task-based Simulations from Roger CPA Review, with expert-written explanations and solu-
tions. All questions are either directly from the AICPA or are modeled on AICPA questions that appear in the
exam. Task-based Simulations are delivered via the Roger CPA Review platform, which mirrors the look, feel and
functionality of the actual exam. McGraw-Hill Education and Roger CPA Review are dedicated to supporting ev-
ery accounting student along their journey, ultimately helping them achieve career success in the accounting profes-
sion. For more information about the full Roger CPA Review program, exam requirements and exam content, visit
www.rogercpareview.com.
xi
A STORYLINE APPROACH THAT WILL
RESONATE WITH STUDENTS
Each chapter begins with a storyline that
introduces a set of characters facing
Storyline Summary ­specific tax-related situations. This revo-
lutionary approach to teaching tax em-
Taxpayers: Courtney Wilson, age 40,
Courtney’s mother Dorothy “Gram” Weiss,
age 70

Family
description:
Courtney is divorced with a son, Deron,
age 10, and a daughter, Ellen, age 20.
Gram is currently residing with Courtney.
phasizes real people facing real tax
Location: Kansas City, Missouri dilemmas. Students learn to apply practi-
cal tax information to specific business
© Image Source Employment Courtney works as an architect for EWD.
status: Gram is retired.

C and personal situations. As their situations

ourtney has already determined her Filing status:
taxable income. Now she’s working
Current
on computing her tax liability. She
knows she owes a significant amount of regu-
situation:
lar income tax on her employment and busi-
ness activities. However, she’s not sure how to
compute the tax on the qualified dividends she re-
ceived from General Electric. Courtney is worried
that she may be subject to the alternative minimum
tax this year because she’s heard that an increasing
number of taxpayers in her income range must pay
the tax. Finally, Courtney knows she owes some self-
employment taxes on her business income. Courtney
would like to determine whether she is eligible to
claim any tax credits such as the child tax credit for
her two children and education credits because she
paid for a portion of her daughter Ellen’s tuition at
the University of Missouri–Kansas City this year.
Courtney is hoping that she has paid enough in taxes
Courtney is head of household. Gram is
single.
Courtney and Gram have computed their
taxable income. Now they are trying to
determine their tax liability, tax refund
or additional taxes due, and whether they
evolve, the characters are brought further
owe any payment-related penalties.
to life.
during the year to avoid underpayment penalties.
She’s planning on filing her tax return and paying
her taxes on time.
Gram’s tax situation is much more straight-
forward. She needs to determine the regular income tax
on her taxable income. Her income is so low she knows
she need not worry about the alternative minimum tax, “The text provides very useful tools that
and she believes she doesn’t owe any self-employment
tax. Gram didn’t prepay any taxes this year, so she is
students can read and understand, making
concerned that she might be required to pay an under- it easier to break the myth that ‘tax is
payment penalty. She also expects to file her tax return
and pay her taxes by the looming due date. hard.’”
to be continued . . .

– Daniel Hoops, Walsh College

Examples
“I absolutely love this textbook. This text-
Examples are the cornerstone of book makes my job of teaching so much
any textbook covering taxation. easier.”
For this reason, McGraw-Hill’s 8-1

Taxation authors took special care – Chuck Pier, Angelo State University
2-4 CHAPTER 2 Tax Compliance, the IRS, and Tax Authorities
to create clear and helpful exam-
spi11838_ch08_000-055.indd 1
The statute of limitations for IRS assessment can be extended in certain circumstances.
1/13/17 8:44 PM

ples that relate to the storyline For example, a six-year statute of limitations applies to IRS assessments if the taxpayer
omits items of gross income that exceed 25 percent of the gross income reported on the tax
of the chapter. Students learn to return. For fraudulent returns, or if the taxpayer fails to file a tax return, the news is under-
standably worse. The statute of limitations remains open indefinitely in these cases.
refer to the facts presented in the
storyline and apply them to other Example 2-1

­scenarios—in this way, they build Bill and Mercedes file their 2013 federal tax return on September 6, 2014, after receiving an auto-
matic extension to file their return by October 15, 2014. In 2017, the IRS selects their 2013 tax return

a greater base of knowledge for audit. When does the statute of limitations end for Bill and Mercedes’s 2013 tax return?
Answer: Assuming the six-year and “unlimited” statute of limitation rules do not apply, the statute

through application. Many exam- of limitations ends on September 6, 2017 (three years after the later of the actual filing date and the
original due date).

ples also include “What if?” sce- What if: When would the statute of limitations end for Bill and Mercedes for their 2013 tax return if the
couple filed the return on March 22, 2014 (before the original due date of April 15, 2014)?

narios that add more complexity Answer: In this scenario the statute of limitations would end on April 15, 2017, because the later of
the actual filing date and the original due date is April 15, 2014.

to the example or explore related

tax concepts. Taxpayers should prepare for the possibility of an audit by retaining all supporting doc-
uments (receipts, cancelled checks, etc.) for a tax return until the statute of limitations ex-
pires. After the statute of limitations expires, taxpayers can discard the majority of supporting
documents but should still keep a copy of the tax return itself, as well as any documents that
may have ongoing significance, such as those establishing the taxpayer’s basis or original
“The case study approach is ex- investment in existing assets like personal residences and long-term investments.

cellent as you follow the taxpayers

LO 2-2 IRS AUDIT SELECTION
through the chapters.” Why me? This is a recurring question in life and definitely a common taxpayer question after
receiving an IRS audit notice. The answer, in general, is that a taxpayer’s return is selected
– Irwin Uhr, Hunter College for audit because the IRS has data suggesting the taxpayer’s tax return has a high probability
of a significant understated tax liability. Budget constraints limit the IRS’s ability to audit a
majority or even a large minority of tax returns. Currently, fewer than 1 percent of all tax
returns are audited. Thus, the IRS must be strategic in selecting returns for audit in an effort
to promote the highest level of voluntary taxpayer compliance and increase tax revenues.
xii Specifically, how does the IRS select tax returns for audit? The IRS uses a number of
computer programs and outside data sources (newspapers, financial statement disclo-
sures, informants, and other public and private sources) to identify tax returns that may
have an understated tax liability. Common computer initiatives include the DIF (Discri-
minant Function) system, the document perfection program, and the information
matching program. The most important of these initiatives is the DIF system. The DIF
system assigns a score to each tax return that represents the probability the tax liability on
THE PEDAGOGY YOUR STUDENTS NEED
TO PUT THE CODE IN CONTEXT CHAPTER 1 An Introduction to Tax 1-3

TAXES IN THE REAL WORLD Republicans vs. Democrats

Taxes in the Real World CHAPTER 1 An Introduction to Tax 1-5
Tax Policy: Republicans versus Democrats Democrats
Taxes in the Real World are short boxes used Oliver Wendell Holmes said “taxes are the price
“At a time of massive income and wealth inequal-
we pay to live in a civilized society.” Both Demo-
ity, we believe the wealthiest Americans and larg-
throughout the book to demonstrate the real-world Example 1-1
crats and Republicans desire the same things: a
est corporations must pay their fair share of
civilized society and a healthy economy. How-
taxes. Democrats will claw back tax breaks for

use of tax concepts. Current articles

Margaret on taxAlabama,
travels to Birmingham, issues,where she rents a hotel room and dines at several restau- ever, neither party can agree on what defines a
companies that ship jobs overseas, eliminate tax
civilized society or which path best leads to a
breaks for big oil and gas companies, and crack
rants. The price she pays for her hotel room and meals includes an additional 2 percent city surcharge
the real-world applicationto fund
of roadway
chapter-specific tax
construction in Birmingham. Is this a tax?
healthy economy. The U.S. national debt is
down on inversions and other methods compa-
$20 trillion dollars and growing, yet the only thing
nies use to dodge their tax responsibilities … We
we might agree on is that something has gone
will then use the revenue raised from fixing the
rules, and short vignettes on popular news about tax
Answer: Yes. The payment is required by a local government and does not directly relate to a specific
benefit that Margaret receives.
wrong. Regardless of which party or candidate
corporate tax code to reinvest in rebuilding
you support, each party’s agenda will affect your
America and ensuring economic growth that will

are some of the issues covered in Taxes in the Real income and taxes in various ways.
lead to millions of good-paying jobs.”
To explore the divide, let’s examine excerpts
“We will ensure those at the top contribute to

World boxes. from each party’s National Platform from our most
Example 1-2
our country’s future by establishing a multimillion-
recent presidential election (2016).
aire surtax to ensure millionaires and billionaires
pay their fair share. In addition, we will shut down
Republicans the “private tax system” for those at the top, im-
“We areand
Margaret’s parents, Bill and Mercedes, recently built a house the party
wereofassessed
a growing economy
$1,000that by their
mediately close egregious loopholes like those
gives everyone a chance in life, an opportunity to enjoyed by hedge fund managers, restore fair
county government to connect to the county sewer system. Is this a tax?
“The Spilker text makes tax easy for students to under-
Answer: No. The assessment was mandatory and it wasmakes
learn, work, and realize the prosperity freedom
paid possible.”
to a local government. However, millionaires
taxation on multimillion dollar estates, and ensure
the can no longer pay a lower rate than

stand. It integrates great real-world examples so

“Government cannot create prosperity, their secretaries. At a time of near-record corpo-
third criterion was not met since the payment directly relates to a specific benefit (sewer service)
though government can limit or destroy it. Pros- rate profits, slow wage growth, and rising costs,
received by the payees. For the same reason, tolls, parkingperity
meteris thefees, and
product annual licensing
of self-discipline, fees we
enterprise, areneed to offer tax relief to middle-class
­students can see how topics will be applied in practice.
also not considered taxes. saving and investment by individuals, but it is not families—not those at the top.”
an end in itself. Prosperity provides the means by
The integration of the tax form and exhibits of the tax “We will offer tax relief to hard working, middle-
which citizens and their families can maintain class families for the cost squeeze they have
their independence from government, raise their faced for years from rising health care, childcare,
forms in the text are outstanding.”
HOW TO CALCULATE A TAX children by their own values, practice their faith,
and build communities of cooperation and mu-
education, andLO 1-3expenses.” https://www
other
.democrats.org/party-platform#preamble
tual respect.”
– Kristen In its simplest
Bigbee, form,Tech
Texas the amount of tax equals the tax base multiplied by the tax rate:
University “Republicans consider the establishment of Conclusion
a pro-growth tax code a moral imperative. Each party fundamentally believes the govern-
More than any other public policy, the way gov- ment should create/maintain cities and states that
Eq. 1-1 Tax = Tax Base × Tax Rate
ernment raises revenue—how much, at what form a civilized society, and that government
should foster a healthy economy. However, they THE KEY FACTS
rates, under what circumstances, from whom,
and for whom—has the greatest impact on our choose very different paths to reach this objec- What Qualifies
The tax base defines what is actually taxed and is usually expressed in monetary
The Key Facts terms, whereas the tax rate determines the level of taxes imposed on the tax base and is
economy’s performance. It powerfully influ-
ences the level of economic growth and job
tive. Democrats want to raise taxes on the
wealthy and createTHE KEYprograms
government FACTS which
as a Tax?
• The general purpose of

The Key Facts pro- usually expressed as a percentage. For example, a sales tax rate of 6 percent on a purchase creation, which translates into the level of op-
portunity for those who would otherwise be left
cost more money, while Republicans wish to
How to government
lower taxes and decrease Calculate asize Taxand
taxes is to fund govern-
ment agencies.
of $30 yields a tax of $1.80 ($1.80 = $30 × .06). • Unlike fines or penalties,
vide quick synopses
behind.” spending. Both •motivesTax =are Taxpure;
basehowever, cur-
× Tax rate
rent and cumulative deficits indicate that current taxes are not meant to
Federal, state, and local jurisdictions use a large variety of tax bases to collect tax. “A strong economy is one key to debt reduc-
tion, but spending restraint is a necessary com-
• The taxtobase
revenue is insufficient meetdefines what
government punish or prevent illegal

of the critical pieces Some common tax bases (and related taxes) include taxable income (federal and state ponent that must be vigorously pursued.” https:// spending. Solving isthese actually taxed will
problems
usuallyandexpressed
andrequire
in
is behavior; however, “sin
taxes” are meant to dis-
income taxes), purchases (sales tax), real estate values (real estate tax), and personal www.gop.com/platform/restoring-the-american- civil discourse, education research/informa-

of information pre- property values (personal property tax).

courage some behaviors.
dream/ tion in order to find realistic, effective
monetary terms. solutions.
• To qualify as a tax, three
• The tax rate determines criteria must be met. The

sented throughout to anDifferent portions of a tax base may be taxed at different rates. A single tax applied
entire base constitutes a flat tax. In the case ofIngraduated summary, taxes affect the
taxes, manybase aspects
the level of taxes imposed
of personal, business, and political decisions.
is divided
payment must be:
• required;
on the
youtaxtobase andinformed
is
each chapter. into a series of monetary amounts, or brackets, and
Developing a solid understanding of taxation should allow
eachin successive
decisions these areas. Thus, bracket Margaretis taxed
can take at comfort
a usually
that
make
her expressed
semester aswilla likely
• imposed by a
government;
different (gradually higher or gradually lower) percentage prove useful rate.to her personally. Who knows? Depending on
CHAPTER 2 Tax Compliance, the IRS, and Tax Authorities 2-7 percentage.
her interest in business, • and not tied directly to
the benefit received by
Calculating some taxes—income taxes for individuals or corporations,
investment, retirement planning, for and example—
the like, she may ultimately • Different decide
portionstoof pursue
a a
Exhibits career inProcess
EXHIBIT 2-2 IRS Appeals/Litigation
can be quite complex. Advocates of flat taxes argue taxation.
that the process should be simpler. But tax base may be taxed
the taxpayer.

at different rates.
Today’s students are visual
as we’ll seelearners,
IRS Exam
throughout the text, most of the difficulty
1a. Agree with proposed
adjustment in calculating proposeda taxadjustment
rests in determin-
1b. Disagree with

ing the tax base, not the tax rate. Indeed, there are only three basic tax rate structures (pro-
and McGraw-Hill’s Taxation delivers
portional, progressive, and regressive),Payand each can be mastered without much
Taxes Due
difficulty.
30-Day Letter

by making appropriate use of charts,

DIFFERENT WAYS TO MEASURE TAX RATES
diagrams, and tabular demonstrations spi11838_ch01_000-029.indd 3 3a. Agree with proposed
adjustment
2a. Request appeals
2b. No

Before we discuss the alternative tax rate structures, let’s first define three different tax Appeals Conference taxpayer

of key material. rates that will be useful in contrasting the different tax rate structures: the marginal, File Suit in U.S. District
3b. Disagree with proposed adjustment
response

File Claim for

average, and effective tax rates. CourtFederal
or U.S. Court of
Claims
5. IRS denies
refund claim
Refund with the IRS
4b. Pay tax
90-Day Letter

The marginal tax rate is the tax rate that applies to the next additional increment of
a taxpayer’s taxable income (or deductions). Specifically,
4a. Do not pay tax;
Petition Tax Court

“A good textbook that uses great Marginal Tax Rate = Tax Court

­examples throughout the chapters to ΔTax* (New Total Tax − Old Total Tax)
Eq. 1-2 =
ΔTaxable Income (New Taxable Income − Old Taxable Income)
give a student an understanding of the IRS Exam: © Royalty-Free/Corbis, Supreme Court: © McGraw-Hill Education/Jill Braaten, photographer, File Claim: © Michael A. Keller/Corbis

*Δ means change in.

tax theory and how it applies to the Claims to interpret and rule differently on the same basic tax issue. Given a choice of
courts, the taxpayer should prefer the court most likely to rule favorably on his or her
particular issues. The courts also differ in other ways. For example, the U.S. District
taxpayers.” “Spilker’s use of examples immediately following the
Court is the only court that provides for a jury trial; the U.S. Tax Court is the only court
that allows tax cases to be heard before the taxpayer pays the disputed liability and the
only court with a small claims division (hearing claims involving disputed liabilities of
concept is a great way to reinforce the concepts.”
$50,000 or less); the U.S. Tax Court judges are tax experts, whereas the U.S. District
– Jennifer Wright, Court and U.S. Court of Federal Claims judges are generalists. The taxpayer should con-
sider each of these factors in choosing a trial court. For example, if the taxpayer feels very

Drexel University – Karen Wisniewski, County College of Morris

confident in her tax return position but does not have sufficient funds to pay the disputed
liability, she will prefer the U.S. Tax Court. If, instead, the taxpayer is litigating a tax re-
turn position that is low on technical merit but high on emotional appeal, a jury trial in
the local U.S. District Court may be the best option.
spi11838_ch01_000-029.indd 5 What happens after the taxpayer’s case is decided in a trial court? The process may 19/01/17 2:11 PM
not be quite finished. After the trial court’s verdict, the losing party has the right to re-
quest one of the 13 U.S. Circuit Courts of Appeals to hear the case. Exhibit 2-3 depicts
the specific appellant courts for each lower-level court. Both the U.S. Tax Court and local
U.S. District Court cases are appealed to the specific U.S. Circuit Court of Appeals based
on the taxpayer’s residence.9 Cases litigated in Alabama, Florida, and Georgia, for example,

9
Decisions rendered by the U.S. Tax Court Small Claims Division cannot be appealed by the taxpayer or the IRS.
xiii

spi11838_ch02_000-035.indd 7 01/11/17 9:25 PM

 the appeals officer may consider the hazards of litigation. Accordingly, Bill and Mercedes
have a good likelihood of a favorable resolution at the appeals conference.
In this chapter we discussed several of the fundamentals of tax practice and proce-
dure: taxpayer filing requirements, the statute of limitations, the IRS audit process, the
primary tax authorities, tax research, tax professional standards, and taxpayer and tax
practitioner penalties. For the tax accountant, these fundamentals form the basis for much
of her work. Likewise, tax research forms the basis of much of a tax professional’s com-
pliance and planning services. Even for the accountant who doesn’t specialize in tax ac-

PRACTICE MAKES PERFECT WITH A

counting, gaining a basic understanding of tax practice and procedure is important.
Assisting clients with the IRS audit process is a valued service that accountants provide,
and clients expect all accountants to understand basic tax procedure issues and how to
research basic tax issues.

Summary Summary
LO 2-1 Identify the filing requirements for income tax returns and the statute of limitations for A unique feature of McGraw-Hill’s
assessment.
• All corporations must file a tax return annually regardless of their taxable income. Estates Taxation is the end-of-chapter sum-
and trusts are required to file annual income tax returns if their gross income exceeds
$600. The filing requirements for individual taxpayers depend on the taxpayer’s filing mary organized around learning
status, age, and gross income.
• Individual and C corporation tax returns (except for C corporations with a June 30 year-end) ­objectives. Each objective has a
are due on the fifteenth day of the fourth month following year-end. For C corporations
with a June 30 year-end, partnerships and S corporations, tax returns must be filed by the brief, bullet-point summary that
covers the major topics and con-
fifteenth day of the third month following the entity’s fiscal year-end. Any taxpayer unable
to file a tax return by the original due date can request an extension to file.

cepts for that chapter, including

2-30 CHAPTER 2
Tax Compliance,
KEY TERMS
LO 2-2
30-day letter (2-6)
90-day letter (2-6)
• The three types of IRS audits consist of correspondence, office,statute
acquiescence (2-17)
• After the audit, the IRS will send the taxpayer a 30-day letter, which provides the taxpayer
action on decision (2-17)
annotated tax service (2-18)
Circular 230 (2-24)
citator (2-21)
civil penalties (2-26)
• For both amended tax returns filed by a taxpayer and proposed tax assessments by the
IRS,the
theIRS,
statute of limitations
and generally ends three years from the later of (1) the date the
Tax Authorities
chapter
Tax Compliance,
tax return was actually filed or (2) the tax return’s original due date.
­references to critical exhibits and
2
happens after the audit. the IRS, and Tax
Outline the IRS audit process, how returns are selected, the different types of audits, and what
examples. All end-of-chapter mate-
Authorities
• The IRS uses a number of computer programs and outside data sources to identify tax
returns that may have an understated tax liability. Common computer initiatives include the
information matching program (2-4) Statements on Standards for rial
Taxis tied to learning objectives.
DIF (Discriminant Function) system, the document perfection program, and the information
matching Internal
program.Revenue Code of 1986 (2-11) Services (SSTS) (2-23)
of limitations (2-3)
and field examinations.
interpretative regulations (2-16)
legislative
the opportunity to pay regulations
the proposed(2-16) assessment or request an substantial authority (2-24)
appeals conference.
If an agreement is not reached at appeals or the taxpayer does
nonacquiescence (2-17) taxnottreaties (2-14)
pay the proposed
Learning Objectives
office examination (2-6) technical advice memorandum “You can tell the authors of this text-
(2-16)
Upon completing this chapter, you should be able to:
primary authorities (2-9) temporary regulations (2-15)
book are still in the classroom and
LO 2-1 private
Identify theletter rulings
filing requirements (2-16)
for income tax returns and the statute topical
of limitationstax
for service (2-19)

correspondence examination (2-5)

assessment.
procedural regulations (2-16) U.S. Circuit Courts of Appeals ­responsible
(2-7) for the day-to-day
U.S. Constitution (2-11) ­education of accounting students.
LO 2-2 Outline the IRS audit process, how returns are selected, the different types of audits, and
criminal penalties (2-26)
spi11838_ch02_000-035.indd 28
proposed regulations
what happens after the audit. (2-15) 01/11/17 2:51 PM
determination letters (2-16) LO 2-3 question of fact
Evaluate the relative (2-19)
weights of the various tax law sources. U.S. Court of Federal Claims ­Examples
(2-6) are representative of the
DIF (Discriminant Function) question of law (2-19) U.S. District Court (2-6)
LO 2-4 Describe the legislative process as it pertains to taxation.
end-of-chapter problems, and the
system (2-4) LO 2-5 regulations (2-15)
Perform the basic steps U.S.when
in tax research and evaluate various tax law sources Supreme
faced Court (2-8)
document perfection program (2-4) with ambiguous statutes.
revenue procedures (2-16) U.S. Tax Court (2-6) end-of-chapter summary is an excellent
field examination (2-6) LO 2-6 Describe tax professional responsibilities in providing tax advice.
revenue rulings (2-16) writ of certiorari (2-8) study tool.”
LO 2-7 Identify taxpayer and tax professional penalties.
final regulations (2-15) secondary authorities (2-9)
Golsen rule (2-15) stare decisis (2-15)
– Debra Petrizzo, Franklin University

Discussion
DISCUSSION QUESTIONS Questions
Discussion Questions are available in Connect®. Discussion questions,
LO 2-1 1. Name three factors that determine whether a taxpayer is required to file a tax
spi11838_ch02_000-035.indd 1 01/11/17 2:50 PM
now available in Con-
return. nect, are provided for
2. Benita is concerned that she will not be able to complete her tax return by April 15.
LO 2-1
Can she request an extension to file her return? By what date must she do so? each of the major con-
Assuming she requests an extension, what is the latest date that she could file cepts in each chapter,
her return this year without penalty?
providing students
LO 2-1 3. Agua Linda Inc. is a calendar-year corporation. What is the original due date for
the corporate tax return? What happens if the original due date falls on a with an opportunity
Saturday? to review key parts of
4. Approximately what percentage of tax returns does the IRS audit? What are the
LO 2-2
implications of this number for the IRS’s strategy in selecting returns for audit?
the chapter and answer
“This 5. Explain
LO 2-2 is a very the difference
readable between the
text. Students willDIF system and the
understand National
it on theirResearch
own, Program. evocative questions
How do they relate to each other?
generally, freeing more class time for application, practice, and student about what they have
6. Describe the differences between the three types of audits in terms of their scope
LO 2-2
questions.” and taxpayer type. learned.
LO 2-2 7. Simon just received a 30-day letter from the IRS indicating a proposed assessment.
Does he have to pay the additional tax? What are his – Valrie Chambers,
options?
LO 2-2 8. Compare and contrast the Texas
three A&M
trial-level University–Corpus
courts. Christi
LO 2-3 9. Compare and contrast the three types of tax law sources and give examples of
each.
LO 2-3 10. The U.S. Constitution is the highest tax authority but provides very little in the
way of tax laws. What are the next highest tax authorities beneath the U.S.
Constitution?
LO 2-3 11. Jackie has just opened her copy of the Code for the first time. She looks at the
xiv table of contents and wonders why it is organized the way it is. She questions
whether it makes sense to try and understand the Code’s organization. What are
 b) As a salesperson, Alyssa incurred $2,000 in travel expenses related to her
employment that were not reimbursed by her employer.
2-32 CHAPTER 2 Tax Compliance, the IRS, and Tax Authorities
c) The Johnsons own a piece of raw land held as an investment. They paid $500 of
real property taxes on the property and they incurred $200 of expenses in travel
LO 2-6 37.costs
Levitoissee recommending
the property and a taxto return
evaluate position to his client.
other similar potential What standard must he
investment
meet to satisfy his professional standards? What is the source of this professional
properties.
standard?
d) The Johnsons own a rental home. They incurred $8,500 of expenses associated
LO 2-6 38.withWhat theisproperty.
Circular 230?
LO 2-7 39.
e) TheWhat are the home
Johnsons’ basic differences
was only five between
miles from civil theandOffice
criminal Depottax store
penalties?
where

WIDE VARIETY OF ASSIGNMENT MATERIAL LO 2-7

LO 2-7

LO 2-7
40.Alyssa
What worked
home,
are some
so the
inof
Johnsons
January
the most andcommon
decided
February.civil
to move
Thepenalties
to
41. What are the taxpayer’s standards to avoid the substantial understatement
The
make
Johnsons’ new home was only 10 miles from the ST store. However, their
penalty?
new home was 50 miles from their former residence. The Johnsons paid a mov-
ST store imposed

42. What are the tax practitioner’s standards to avoid a penalty for recommending a tax
the
was 60 miles
commute easier
from their
on taxpayers?
for Alyssa.
of tax

ing company $2,002 to move their possessions to the new location. They also
return position?
drove the 50 miles to their new residence. They stopped along the way for
lunch and spent $60 eating at Denny’s. None of the moving expenses were
Problems Problems are designed 2-34 CHAPTER 2 Tax Compliance, reimbursed
the IRS, and Tax
PROBLEMS byAuthorities
ST.
f) Jeremy paid $4,500 for health insurance coverage for himself (not through an
to test the comprehension of more LO 2-5 66. Georgette
Select
researchJeremy
has identified
exchange).
problems
question.
Alyssa
is not What
are was
eligible
a 1983
available
must
covered
for the
court bycase
in Connect
she plan
health
do tountil
that
. appears
® plans
determine
next year.
providedto answer
by her her employer, but
if the case still represents
complex topics. Each problem at the LO 2-5
43.
LO 2-1 “current”
67. Sandyportion
Ahmed
g) Jeremy law? paid
thatdetermined
has heofcan
does not have
$2,500
therequest thatan
self-employment
enough cash ontaxes
in self-employment
herextension
research to
taxes).
hand($1,250
to pay his
file his depends
question tax return.
taxes. He
represents
Does
upon thethis
thewas excited to hear
employer
solve his problem?
interpretation
end of the chapter is tied to one of that of the What are
phrase “not the ramifications
compensated by ifinsurance.”
he doesn’t pay
h) Jeremy paid $5,000 in alimony and $3,000 in child support from his prior
44.marriage.
LO 2-1 is this?
What histype
tax of
Molto Stancha Corporation had zero earnings this fiscal year; in fact, it lost money.
liability
research by April
question 15?

chapter’s learning objectives, with LO 2-5 68. J. C.i) has

LO 2-1 believes
45.The
Must
beenpaid
Alyssa the
theJohnsons
The
corporation
a professional
$3,100 of tuition
incomeofwould
estate isMonique
tax-free.
file
gambler
like to
a
Chablis
tax return?
andforfees
deductearned
many
as much
years.night
to attend
$450
He loves
classes
of income
of this
thisatline
expenditure
of work
a local
this year.
and
university.
Is the rather
as possible estate
research
multiple problems for critical topics. LO 2-1
a) Usethan
46.
j) The
required
an
correct.
claim to
available
Jamarcus,
Johnsons
file
tax an
a credit.
Is the answera full-time
donated
income
research
to this
tax return?
service
question
student,
$2,000
to determine whether J. C.’s thinking is
found
to earned
their in thecharity.
$2,500
favorite Internal
this yearRevenue
from a summer Code? Ifjob. He had
not, what
no other typeincome
of authoritythis year answers
and will this question?
have zero federal income tax liability this year.
70. Shauna Coleman is single. She is employed as an architectural designer for Stream-
Tax Forms Problems Tax forms tax forms
LO 2-5
b)
69. Katie
Write His
a
recently
correctly
employer
memo
calculated
withheld $300
communicating
a ceramic AGI.
the of federal
results
a tax return?
dalmatian
However, valued
of income
your
line Design (SD). Shauna wanted to determine her taxable income for this year. She
Jamarcus wonrequired her to file Should
at $800
she wasn’t
tax from his summer pay. Is
research.
Jamarcus
sureonhow to file
a television a tax
compute game return?
the rest of
problems are a set of requirements research
LO 2-1 show.47.
herShe
on the
Shane
taxable
gambler.
show.
has
questions never
income.
When
whether
Shefiled
does
a tax
this
provided
the
could use it to determine her taxable income.
return
prize
statute of
despitesince
theisfollowing
taxable
limitations
earning
information excessive
it was
expire
awith
for
“gift”
the
sums
she won
hopes
years
of money
that
in
you as a
which Shane
hasavailable
not paid
filedtax a tax return?
included in the end-of-chapter material a) Use
a) an
LO 2-1 b) Write
Shauna
48. Shauna’s
Latoya
a letterfiled
$4,680
boyfriend,
to Katie
research
her tax Blake,
communicating
serviceexpenses
for medical
returndrove
to answer
on February
Shauna
the results
forKatie’s
10
care from
(in this
her
question.
a broken ankle. Also,
year.aresearch.
car)
of your When
total ofwill 115themilesstatute
to theof limita-
tions expire forsothis tax return?
of the 2018 edition. These problems
doctor’s
70. Pierre recently office
received ashe
taxcouldpenalty receive care for
for failing to her
file broken ankle.He was upset
a tax return.
LO 2-5
49. Using
b) Shauna
LO 2-1 to receive the penalty, but he was comforted by the thought that he will get a tax (notif
the
paidfacts
a from
total of the previous
$3,400 in problem,
health insurance how would
premiums your answer
during the change
year
through
Latoya an exchange).
understated her SDincome
did notby reimburse
40 percent? any Howof thiswould
expense. yourBesides
answerthe change if
require students to complete a tax form
research deduction for paying the penalty.
a) Use an Latoya
availableintentionally
tax research failed to report
service as taxableif income
to determine Pierre isany cash payments she
correct.
received from her clients?
(or part of a tax form), providing students with valuable experience and practice with filling out these
LO 2-2
b) Write a memo communicating the results of your research.
50. Paula could not reach an agreement with the IRS at her appeals conference and has
71. Paris was
LO 2-5
justhappy
received to provide
a 90-day a contribution
letter. If she wants to her to friend
litigateNicole’s
the issue campaign
but doesfor not have
forms. These requirements—and their relevant forms—are also included in Connect. Each tax form
research
mayor, sufficient
deductible.
especiallycash aftertoshe paylearned that charitable
the proposed deficiency, contributions
what is herare besttaxcourt choice?
51. In choosing a trial-level court, how should a court’s previous rulings influence the
problem includes an icon to differentiate it from regular problems.
LO 2-2
a) Use an available
choice? Howtax service
should to determine
circuit court rulings whether Paris can
influence thededuct
taxpayer’s this choice of a trial-
spi11838_ch06_000-055.indd 52 contribution. 1/13/17 5:06 PM
level court?
b) Write a memo
52. Sophia communicating
recently won a taxthe case results
litigatedof your
in the research.
7th Circuit. She recently heard
Research Problems Research
LO 2-2
LO 2-5 72. Matt and Lori
that therecently
Supreme wereCourt divorced.
deniedAlthough
the writ of grief stricken,Should
certiorari. Matt was sheatbeleast
happy or not,
partiallyand comforted
why? by his monthly receipt of $10,000 alimony. He was particularly
problems are special problems research
LO 2-2
excited to learn from his friend, Denzel, that the alimony was not taxable. Use an
53. Campbell’s tax return was audited because she failed to report interest she earned
available tax service to determine if Denzel is correct. Would your answer change
on her tax return. What IRS audit selection method identified her tax return?
throughout the end-of-chapter LO 2-5
LO 2-2
if Matt and Lori continued to live together?
54. Yong’s tax return was audited because he calculated his tax liability incorrectly.
73. Shaun is a huge college football fan. In the past, he has always bought football
What IRS audit procedure identified his tax return for audit?
assignment material. These tickets on the street from ticket scalpers. This year, he decided to join the univer-
research LO 2-2 sity’s 55.ticket
Randy deducted
program, whicha high level of
requires itemized
a $2,000 deductionstotwo
contribution the years
universityago relative to his
incometo level. He recently
tickets. received an then
IRS notice requesting documentation for
require students to do both basic for the “right”
his itemizedthat
Shaun understands
for audit?
purchase
deductions.
the price What
Shaun will
paid for audit
theprocedure
pay $400
season tickets likely
per season
is identified
ticket.
his tax return
not tax deductible
as a charitable contribution. However, contributions to a university are typically
and more complex research on topics outside of the scope of the book. Each research problem includes
tax deductible.
a) Use an available tax service to determine how much, if any, of Shaun’s $2,000
an icon to differentiate it from regular problems. contribution for the right to purchase tickets is tax deductible.
b) Write a letter to Shaun communicating the results of your research.
LO 2-5 74. Latrell recently used his Delta Skymiles to purchase a free round-trip ticket to
Milan, Italy (value $1,200). The frequent flyer miles used to purchase the ticket
“The textbook is comprehensive, uses an integrated approach to taxation, contains clear illustrations
research
spi11838_ch02_000-035.indd 32
were generated from Latrell’s business travel as a CPA. Latrell’s employer paid for
01/11/17 2:51 PM
his business trips, and he was not taxed on the travel reimbursement.
and examples in each chapter, and has a wealth of end-of-chapter assignment material.”
4-40 CHAPTER 4 Individual Income Tax Overview, Exemptions, and Filing Status
a) Use an available tax research service to determine how much income, if any,
Latrell will have to recognize as a result of purchasing an airline ticket with
a separate tax return. In year 4, the couple divorced. Both Jasper and Crewella filed sin-
Skymiles
b) Write anda each
memo
– James P. Trebby, Marquette University
earned from business travel.
gle tax returns in year 4. In year 5, the IRS audited the couple’s joint year 2 tax return
communicating
spouse’s separate yearthe results
3 tax returns.of The
yourIRS research.
determined that the year 2 joint
return and Crewella’s separate year 3 tax
CHAPTER 2 return understatedthe
Tax Compliance, Crewella’s self-employ-
IRS, and Tax Authorities 2-33
ment income, causing the joint return year 2 tax liability to be understated by $4,000
Planning Problems Planning problems 56. and Crewella’s
Jackie has a corporate client
also assessed
with a $100,000 tax assessment.
year 3 separate
that has recently
Herpenalties
client is and
received return tax liability
a 30-day
interest on
considering
notice to
both of these
requesting
frombe understated
the IRS by
LO$6,000.
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tax returns. Try as it might, the IRS
an appeals planning
are another unique set of problems conference to contest the hasassessment.
not been able
a) What
to consider before requesting anamount
to locate
What
appealsof
factors Crewella, but theyadvise
should Jackie have been able to find Jasper.
her client
tax can the IRS require Jasper to pay for the Dahvill’s year 2
conference?
joint
anreturn?
audit ofExplain.
included in the end-of-chapter
57. The IRS recently completed Shea’s tax return and assessed $15,000 ad- LO 2-2

spi11838_ch02_000-035.indd 34
ditional tax. Shea requestedb) What amountconference
an appeals of tax can the butIRS
was require
unable Jasper
to settletothe paycase
for Crewella’s year 3
planning 01/11/17 2:51 PM
separate tax return?
at the conference. She is contemplating whichExplain.
trial court to choose to hear her case.
assignment material. These require Provide aLOrecommendation
4-3 51. Janice
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based on the
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onlyCircuit,
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and the
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has2nd
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lived with has
Circuit Janice
facts: son named Marty. Marty is Janice’s
has an 18-year-old
his entire
recently ruledlife. However,
against the Marty recently

students to test their tax planning skills research

position joined the Marines and was sent on a special assignment to Australia. During the
Shea is litigating.
b) The Federal Circuit current
Court ofyear, Martyhas
Appeals spent nine months
recently ruled ininfavor Australia.
of Shea’s Marty was extremely homesick
while in Australia, since he had never lived away from home. However, Marty knew
after covering the chapter topics. Each planning problem includes an icon to differentiate it from
position.
c) The issue being litigatedthis assignment was onlyof
involves a question temporary,
fact. Sheaand hashe couldn’t
a very wait to come home and find his
appealing
story to tell but littleroom just the
favorable casewaylawhetoleft it. Janice
support her has always filed as head of household, and Marty
position.
regular problems. has always been considered a qualifying child (and he continues to meet all the tests
d) The issue being litigated is highly technical, and Shea believes strongly in her
with the possible exception of the residence test due to his stay in Australia). How-
interpretation of the law.
ever, this year Janice is unsure whether she qualifies as head of household due to
e) Shea is a local elected official and wouldabsenceprefer toduring
minimize any Janice
local publicity
Comprehensive and tax return problems address
Marty’s nine-month the year. has come to you for advice on
Comprehensive and Tax Return Problems 58.
regarding the case. whether she qualifies for head of household filing status. What do you tell her?
Juanita, aLOTexas resident (5th Jones
Circuit), is researching a tax
52. Doug submitted his 2017 taxquestion
return on andtimefindsanda elected toLOfile2-3
a joint tax
multiple concepts in a single problem. Comprehensive problems are ideal for cumulative topics; for
4-3
5th Circuit case ruling return
that is favorable and aDarlene.
with his wife, 9th Circuit Dougcaseand thatDarlene
is unfavorable.
did not request an extension for
Whichresearch
circuit case has their
more2017“authoritative
tax return. weight”
Doug and and why?
Darlene How owedwould andyourpaid the IRS $124,000 for

this reason, they are located at the end of all chapters. In the end-of-book Appendix C, we include tax
answer change if Juanita were
their a Kentucky
2017 tax year.resident
Two years (6thlater,
Circuit)?Doug amended his return and claimed mar-
59. Faith, a resident of Floridaried (11th
filingCircuit)
separaterecently
status. found a circuithis
By changing court case
filing that isDoug sought
status, LO 2-3 a refund
favorable to her research question. Which two circuits
for an overpayment for the tax year 2017 would she prefer
(he paid to have
more tax in the original joint
return problems that cover multiple chapters. Additional
60.
tax return problems are also available in
issued the opinion? return than he owed on a separate return). Is Doug allowed to change his filing
Robert has found a “favorable”
status forauthority
the 2017directly
tax year onand
point for hisa tax
receive taxquestion.
refund with If the
his amended
LO 2-3 return?

the Connect Library. These problems authority is a court case, which court would he prefer to have issued the opinion?
Which court would he least prefer to have issued the opinion?
Jamareo has foundCOMPREHENSIVE PROBLEMS
range from simple to complex and 61. a “favorable” authority directly
the authority is an administrative authority, which specific type
Select problems are available
he prefer to answer his question? Which administrative
on point for his tax question. If
in Connect ®
authority.
of authority would
would he least
LO 2-3

cover individual taxation, corporate 62.

prefer to answer his53.
For each
tax of
forms
question?
the following
Marc and Michelle are married and earned salaries this year of $64,000 and
citations,
$12,000, identify the
respectively. In type of authority
addition (statutory,
to their salaries, admin-
they received interest
LO 2-3 of $350

taxation, partnership taxation, and istrative, or judicial) and explain

from the citation.
municipal bonds and $500 from corporate bonds. Marc and Michelle also paid
a) Reg. Sec. 1.111-1(b)$2,500 of qualifying moving expenses, and Marc paid alimony to a prior spouse in

S corporation taxation. b) IRC Sec. 469(c)(7)(B)(i) the amount of $1,500. Marc and Michelle have a 10-year-old son, Matthew, who
lived with them throughout the entire year. Thus, Marc and Michelle are allowed to
c) Rev. Rul. 82-204, 1982-2 C.B. 192
claim a $1,000 child tax credit for Matthew. Marc and Michelle paid $6,000 of ex-
d) Amdahl Corp., 108 TC 507 (1997)
penditures that qualify as itemized deductions and they had a total of $5,500 in fed-
e) PLR 9727004 eral income taxes withheld from their paychecks during the course of the year.
f) Hills v. Comm., 50 AFTR2da) What 82-6070
is Marc and (11th Cir., 1982)
Michelle’s gross income?
63. For each of the following citations,
b) What identify
is Marc and the type of adjusted
Michelle’s authoritygross (statutory,
income? admin- LO 2-3
istrative, or judicial) and explain the citation.
c) What is the total amount of Marc and Michelle’s deductions from AGI? xv
a) IRC Sec. 280A(c)(5)d) What is Marc and Michelle’s taxable income?
b) Rev. Proc. 2004-34, e) 2004-1
WhatC.B.
is Marc911and Michelle’s taxes payable or refund due for the year? (Use the
c) Lakewood Associates, RIA TC schedules.)
tax rate Memo 95-3566
d) TAM 200427004 f) Complete the first two pages of Marc and Michelle’s Form 1040 (use 2016 forms
e) U.S. v. Muncy, 2008-2 if USTC
2017par.forms50,449 (E.D., AR, 2008)
are unavailable).
64. Justine would like to clarify her understanding of a code section recently enacted by LO 2-4
Congress. What tax law sources are available to assist Justine?

McGraw-Hill’s Taxation of Individuals is organized to empha-
size topics that are most important to undergraduates taking their
first tax course. The first three chapters provide an introduction
to taxation and then carefully guide students through tax re-
search and tax planning. Part II discusses the fundamental ele-
ments of individual income tax, starting with the tax formula
in Chapter 4 and then proceeding to more discussion on income,
deductions, investments, and computing tax liabilities in
­Chapters 5–8. Part III then discusses tax issues associated with
business-related activities. Specifically, this part addresses busi-
ness income and deductions, accounting methods, and tax conse-
quences associated with purchasing assets and property disposi-
tions (sales, trades, or other dispositions). Part IV is unique
among tax textbooks; this section combines related tax issues for
compensation, retirement savings, and home ownership.
Part I: Introduction to Taxation
1. An Introduction to Tax
2. Tax Compliance, the IRS, and Tax Authorities
3. Tax Planning Strategies and Related Limitations
Part II: Basic Individual Taxation
4. Individual Income Tax Overview, Exemptions and Filing
Status
5. Gross Income and Exclusions
6. Individual Deductions
7. Investments
8. Individual Income Tax Computation and Tax Credits
Part III: Business-Related Transactions
9. Business Income, Deductions, and Accounting Methods
10. Property Acquisition and Cost Recovery
11. Property Dispositions
Part IV: Specialized Topics
12. Compensation
13. Retirement Savings and Deferred Compensation
14. Tax Consequences of Home Ownership
xvi
Four Volumes to Fit
McGraw-Hill’s Taxation of Business Entities begins with the
process for determining gross income and deductions for
­businesses, and the tax consequences associated with purchasing
assets and property dispositions (sales, trades, or other disposi-
tions). Part II provides a comprehensive overview of entities and
the formation, reorganization, and liquidation of corporations.
Unique to this series is a complete chapter on accounting for in-
come taxes, which provides a primer on the basics of calculating
the income tax provision. Included in the narrative is a discus-
sion of temporary and permanent differences and their impact on
a company’s book “effective tax rate.” Part III provides a de-
tailed discussion of partnerships and S corporations. The last
part of the book covers state and local taxation, multinational
taxation, and transfer taxes and wealth planning.
Part I: Business-Related Transactions
1. Business Income, Deductions, and Accounting Methods
2. Property Acquisition and Cost Recovery
3. Property Dispositions
Part II: Entity Overview and Taxation of C Corporations
4. Entities Overview
5. Corporate Operations
6. Accounting for Income Taxes
7. Corporate Taxation: Nonliquidating Distributions
8. Corporate Formation, Reorganization, and Liquidation
Part III: Taxation of Flow-Through Entities
9. Forming and Operating Partnerships
10. Dispositions of Partnership Interests and Partnership
Distributions
11. S Corporations
Part IV: Multijurisdictional Taxation and Transfer Taxes
12. State and Local Taxes
13. The U.S. Taxation of Multinational Transactions
14. Transfer Taxes and Wealth Planning
Four Course Approaches
McGraw-Hill’s Taxation of Individuals and Busi-
ness Entities covers all chapters included in the
two split volumes in one convenient volume.
See Table of Contents.
McGraw-Hill’s Essentials of Federal Taxation is designed for a
one-semester course, covering the basics of taxation of individu-
als and business entities. To facilitate a one-semester course,
McGraw-Hill’s Essentials of Federal Taxation folds the key top-
ics from the investments, compensation, retirement savings, and
home ownership chapters in Taxation of Individuals into three
individual taxation chapters that discuss gross income and
­exclusions, for AGI deductions, and from AGI deductions,
­respectively. The essentials volume also includes a two-chapter
C corporation sequence that uses a life-cycle approach covering
corporate formations and then corporate operations in the first
chapter and nonliquidating and liquidating corporate distribu-
tions in the second chapter. This volume is perfect for those
teaching a one-semester course and for those who struggle to get
through the 25-chapter comprehensive volume.
Part I: Introduction to Taxation
1. An Introduction to Tax
2. Tax Compliance, the IRS, and Tax Authorities
3. Tax Planning Strategies and Related Limitations
Part II: Individual Taxation
4. Individual Income Tax Overview, Exemptions, and Filing
Status
5. Gross Income and Exclusions
6. Individual For AGI Deductions
7. Individual From AGI Deductions
8. Individual Income Tax Computation and Tax Credits
Part III: Business-Related Transactions
9. Business Income, Deductions, and Accounting Methods
10. Property Acquisition and Cost Recovery
11. Property Dispositions
Part IV: Entity Overview and Taxation of C Corporations
12. Entities Overview
13. Corporate Formations and Operations
14. Corporate Nonliquidating and Liquidating Distributions
Part V: Taxation of Flow-Through Entities
15. Forming and Operating Partnerships
16. 
D ispositions of Partnership Interests and Partnership
Distributions
17. S Corporations
xvii
SUPPLEMENTS FOR INSTRUCTORS
Assurance of Learning Ready
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on the notion of assurance of learning, an im-
portant element of many accreditation stan-
dards. McGraw-Hill’s Taxation is designed
specifically to support your assurance of learn-
ing initiatives with a simple, yet powerful,
solution.
Each chapter in the book begins with a list
of numbered learning objectives, which appear
throughout the chapter as well as in the end-of-
chapter assignments. Every test bank question
for McGraw-Hill’s Taxation maps to a specific
chapter learning objective in the textbook. Each
test bank question also identifies topic area,
level of difficulty, Bloom’s Taxonomy level,
and AICPA and AACSB skill area.
AACSB Statement
McGraw-Hill Education is a proud corporate
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The statements contained in McGraw-
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McGraw-Hill’s Taxation and the teaching
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for today’s educators.

A HEARTFELT THANKS TO THE MANY COLLEAGUES WHO SHAPED THIS BOOK

The version of the book you are reading would not be the same book without the valuable suggestions, keen insights,
and constructive criticisms of the list of reviewers below. Each professor listed here contributed in substantive ways
to the organization of chapters, coverage of topics, and the use of pedagogy. We are grateful to them for taking the
time to read chapters or attend reviewer conferences, focus groups, and symposia in support of the development for
the book:
Previous Edition Reviewers Cynthia Bird, Tidewater Community College
Donna Abelli, Mount Ida College Lisa Blum, University of Louisville
Joseph Assalone, Rowan College at Gloucester County Rick Blumenfeld, Sierra College
Valeriya Avdeev, William Paterson University Cindy Bortman Boggess, Babson College
Robyn Barrett, St. Louis Community College Cathalene Bowler, University of Northern Iowa
Kevin Baugess, ICDC College Justin Breidenbach, Ohio Wesleyan University
Christopher Becker, Coastal Carolina University Suzon Bridges, Houston Community College
Jeanne Bedell, Keiser University Stephen Bukowy, UNC Pembroke
Marcia Behrens, Nichols College Esther Bunn, Stephen F. Austin State University
Michael Belleman, St. Clair County Community College Holly Caldwell, Bridgewater College
David Berman, Community College of Philadelphia James Campbell, Thomas College
Tim Biggart, Berry College Alisa Carini, UCSD Extension

xviii
Ronald Carter, Patrick Henry Community College
Cynthia Caruso, Endicott College
Paul Caselton, University of Illinois Springfield
Christine Cheng, Louisiana State University
Amy Chataginer, Mississippi Gulf Coast Community College
Machiavelli Chao, University of California, Irvine
Max Chao, University of California, Irvine
Lisa Church, Rhode Island College
Marilyn Ciolino, Delgado Community College
Wayne Clark, Southwest Baptist University
Ann Cohen, University at Buffalo, SUNY
Sharon Cox, University of Illinois–Urbana-Champaign
Terry Crain, University of Oklahoma–Norman
Roger Crane, Indiana University East
Brad Cripe, Northern Illinois University
Richard Cummings, University of Wisconsin–Whitewater
Joshua Cutler, University of Houston
William Dams, Lenoir Community College
Nichole Dauenhauer, Lakeland Community College
Susan Snow Davis, Green River College
Jim Desimpelare, University of Michigan–Ann Arbor
Julie Dilling, Moraine Park Technical College
Steve Dombrock, Carroll University
John Dorocak, California State University–San Berdinado
Amy Dunbar, University of Connecticut–Storrs
John Eagan, Morehouse College
Reed Easton, Seton Hall University
Elizabeth Ekmekjian, William Paterson University
Ann Esarco, Columbia College Columbia
Frank Faber, St. Joseph’s College
Michael Fagan, Raritan Valley Community College
Frank Farina, Catawba College
Andrew Finley, Claremont McKenna
Tim Fogarty, Case Western Reserve University
Mimi Ford, Middle Georgia State University
Wilhelmina Ford, Middle Georgia State University
George Frankel, SFSU
Lawrence Friedken, Penn State University
Stephen Gara, Drake University
Robert Gary, University of New Mexico
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Earl Godfrey, Gardner Webb University
Thomas Godwin, Purdue University
David Golub, Northeastern University
Marina Grau, Houston Community College
Brian Greenstein, University of Delaware
Patrick Griffin, Lewis University
Lillian Grose, University of Holy Cross
Rosie Hagen, Virginia Western Community College
Marcye Hampton, University of Central Florida
Cass Hausserman, Portland State University
Rebecca Helms, Ivy Tech Community College
Melanie Hicks, Liberty University
Mary Ann Hofmann, Appalachian State University
Robert Joseph Holdren, Muskingum University
Bambi Hora, University of Central Oklahoma
Carol Hughes, Asheville Buncombe Technical Community
College
Helen Hurwitz, Saint Louis University
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Kerry Inger, Auburn University
Paul Johnson, MGCCC–JD Campus
Athena Jones, University of Maryland University College
Andrew Junikiewicz, Temple University
Susan Jurney, University of Arkansas Fayetteville
Sandra Kemper, Regis University
Jon Kerr, Baruch College–CUNY
Lara Kessler, Grand Valley State University
Janice Klimek, University of Central Missouri
Pamela Knight, Columbus Technical College
Satoshi Kojima, East Los Angeles College
Dawn Konicek, Idaho State University
Jack Lachman, Brooklyn College
Brandon Lanciloti, Freed-Hardeman University
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Troy Lewis, Brigham Young University
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Robert Lin, California State University–East Bay
Chris Loiselle, Cornerstone University
Bruce Lubich, Penn State–Harrisburg
Michael Malmfeldt, Shenandoah University
Kate Mantzke, Northern Illinois University
Robert Martin, Kennesaw State University
Anthony Masino, East Tennessee State University
Paul Mason, Baylor University
Lisa McKinney, University of Alabama at Birmingham
Lois McWhorter, Somerset Community College
Allison McLeod, University of North Texas
Janet Meade, University of Houston
Michele Meckfessel, University of Missouri–St. Louis
Frank Messina, University of Alabama at Birmingham
R Miedaner, Lee University
Ken Milani, University of Notre Dame
Karen Morris, Northeast Iowa Community College
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Michelle Moshier, University at Albany
Leslie Mostow, University of Maryland, College Park
James Motter, IUPUI Indianapolis
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Michael Nee, Cape Cod Community College
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Jeff Paterson, Florida State University
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Miles Romney, Michigan State University
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xix
Alisa Shapiro, Raritan Valley Community College
Deanna Sharpe, University of Missouri
Wayne Shaw, Southern Methodist University
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Chris Woehrle, American College
Jennifer Wright, Drexel University
Massood Yahya-Zadeh, George Mason University
James Yang, Montclair State University
Scott Yetmar, Cleveland State University
Charlie Yuan, Elizabeth City State University
Xiaoli Yuan, Elizabeth City State University
Mingjun Zhou, DePaul University

Acknowledgments
We would like to thank the many talented people who made valuable contributions to the creation of this ninth edition.
William A. Padley of Madison Area Technical College, Deanna Sharpe of the University of Missouri–Columbia, and
Troy Lewis of Brigham Young University checked the page proofs and solutions manual for accuracy; we greatly appre-
ciate the hours they spent checking tax forms and double-checking our calculations throughout the book. Teressa F
­ arough,
Troy Lewis of Brigham Young University, and Deanna Sharpe of the University of Missouri–Columbia accuracy-checked
the test bank. Thank you to Troy Lewis, Michele Meckfessel of University of Missouri at St. Louis, and Shannon Book-
out of Columbus State Community College for your contributions to the Smartbook revision for this edition. Special
thanks to Troy Lewis of Brigham Young University for his sharp eye and valuable feedback throughout the revision
process. Thanks as well to Colton Gigot from Agate Publishing for managing the supplement process. Finally, William
A. Padley of Madison Area Technical College, Deanna Sharpe of the University of Missouri–Columbia, and Vivian
Paige of Old Dominion University greatly contributed to the accuracy of McGraw-Hill’s Connect for the 2018 edition.
We also appreciate the expert attention given to this project by the staff at McGraw-Hill Education, especially Tim
Vertovec, Managing Director; Kathleen Klehr, Executive Brand Manager; Danielle Andries, Product Developer; Erin
Quinones, Product Developer; Lori Koetters, Brian Nacik, and Jill Eccher, Content Project Managers; Matt Backhaus,
Designer; Natalie King, Marketing Director; Cheryl Osgood, Marketing Manager; and Sue Culbertson, Senior Buyer.

xx
Changes in Taxation of Individuals
and Business Entities, 2018 Edition
For the 2018 edition of McGraw-Hill’s Taxation of Individuals and Business Entities, many changes
were made in response to feedback from reviewers and focus group participants:
∙ All tax forms have been updated for the latest
­available tax form as of January 2017. In addition,
chapter content throughout the text has been
­updated to reflect tax law changes through
­January 2017.
Other notable changes in the 2018 edition include:
Chapter 1
∙ Updated tax rates for 2017.
∙ Updated Social Security Wage base for 2017.
∙ Updated Unified Tax Credit for 2017.
∙ Updated Taxes in the Real World: Republicans vs.
Democrats.
∙ Updated Taxes in the Real World: Affordable Care
Act amount for 2017.
∙ Updated Taxes in the Real World: National Debt for
current debt limit.
∙ Updated Exhibit 1-4 for 2015 Federal revenues by
source from Treasury.
∙ Updated Exhibit 1-5 for 2015 State revenues by
source from U.S. Census.
Chapter 2
∙ Updated gross income thresholds by filing status
for 2017.
∙ Revised discussion of primary authorities and IRS
Publications and tax forms.
∙ Updated penalty amounts for failure to file a tax re-
turn and willful understatement of tax.
Chapter 3
∙ Updated tax rates for 2017.
∙ Updated Exhibit 3-3 for new tax rates.
Chapter 4
∙ Updated personal exemption amounts for 2017.
∙ Updated standard deduction amounts for 2017.
∙ Updated tax rates for 2017.
∙ Updated tax forms from 2015 to 2016 forms.
∙ Clarified discussion of who is a qualifying person
for head of household filing status for divorced
­parents by editing footnote to Exhibit 4-9 and
­Appendix B.
Chapter 5
∙ Updated for 2017 amounts for Flexible Spending
­Account contributions.
∙ Added discussion of new exclusion for awards and prize
money for Team USA Olympic and Paralympic athletes.
∙ Revised discussion of foreign-earned income exclusion
and updated for 2017 exclusion amounts.
∙ Updated for annual gift tax exclusion and unified tax
credit for 2017.
∙ Updated U.S. Series EE Bond interest income exclusion
for 2017.
∙ Updated tax forms from 2015 to 2016 forms.
Chapter 6
∙ Updated mileage rate for 2017 moving expense
deduction.
∙ Updated phase-out for interest on qualified education
loan for 2017.
∙ Updated pending expiration date for qualified educa-
tion expense deduction.
∙ Updated mileage rate for medical expense itemized
deduction for 2017.
∙ Updated standard business mileage rate for 2017.
∙ Updated thresholds for the itemized deduction and
personal exemption phase-outs for 2017.
∙ Updated standard deduction and personal exemption
amounts for 2017.
∙ Updated tax forms from 2015 to 2016 forms.
Chapter 7
∙ Updated tax rates for 2017.
∙ Updated tax forms from 2015 to 2016 forms.
Chapter 8
∙ Updated tax rate schedules for 2017.
∙ Updated AMT discussion for medical expense
adjustment.
∙ Updated AMT exemption and AMT tax rate schedule
for 2017.
∙ Revised Self-Employment Tax discussion.
∙ Updated Social Security Tax wage base and Self-­
Employment Tax base for 2017.
∙ Updated Lifetime Learning Credit phase-out for 2017.
∙ Updated Earned Income Credit amounts for 2017.
∙ Updated tax forms from 2015 to 2016 forms.
xxi
Chapter 9
∙ Updated standard business mileage rate for 2017.
∙ Updated tax forms from 2015 to 2016.
Chapter 10
∙ Updated tax rates for 2017.
∙ Updated tax forms from 2015 to 2016 forms.
∙ Updated §179 amounts for inflation adjustments.
∙ Updated examples and end of chapter problems for
2017 §179 amounts.
∙ Clarified luxury car (§280F) depreciation limit
calculation.
Chapter 11
∙ Updated tax rates for 2017.
∙ Updated tax forms from 2015 to 2016 forms.
∙ Clarified related-party holding period rules.
∙ Clarified like-kind exchange debt offset rules.
Chapter 12
∙ Updated qualified transportation fringe amounts
for 2017.
∙ Updated tax forms from 2015 to 2016.
∙ Updated Exhibits 12-2 through 12-4 and 12-8 for
2016 proxy statements.
∙ Updated Taxes in the Real World for 2016 proxy
statement information.
Chapter 13
∙ Increased salary for Dave Allan in storyline.
∙ Updated inflation adjusted limits for defined benefit
plans, defined contribution plans, and individually
managed plans.
∙ Updated Exhibit 13-6 to reflect most recent proxy
statement for Coca-Cola Company.
∙ Updated AGI phase-out thresholds for deductible
contributions to traditional IRAs and contributions to
Roth IRAs.
∙ Updated Saver’s credit information.
∙ Clarified language in Discussion Question 33.
∙ Clarified language in Problem 50 part e.
Chapter 14
∙ Clarified that the terms “dwelling unit” and “home”
are used interchangebly.
∙ Updated discussion of government’s list of expendi-
tures from 2015–2024 to 2016–2025.
∙ Updated URL in footnote 4.
∙ Inserted new footnote 7 indicating that the IRS
­recently ruled that a couple’s need to move because
of a birth of a second child was an unforeseen
­circumstance (LTR 201628002).
xxii
∙ In the discussion about combined limit for qualifying
debt, the use of average method and chronological
method of determining deductible interest expense
has been changed to the “simple” and “exact” meth-
ods of determining deductible interest expense, re-
spectively. This is consistent with the terminology
provided in the regulations.
∙ Updated Taxes in the Real World (“Double Take on
Home-Related Interest Deductions”) to reflect the
fact that the IRS has now acquiesced to the Voss 12th
Circuit case. Consequently, the finding in Voss should
apply to taxpayers anywhere in the country.
∙ Updated Example 14-14 dealing with the IRS method
versus Tax Court method of allocating rent expense
to reflect non-leap year in 2017.
∙ Clarified discussion of losses from nonresidential
rental property.
∙ Updated tax forms from 2015 to 2016.
∙ Clarified that taxpayer’s personal use of an office
­disqualifies the taxpayer from claiming a home
­office deduction in Example 14-17.
∙ Updated settlement statement in Appendix A.
∙ Clarified language in Discussion Question 2.
Chapter 15
∙ In Exhibit 15-3, changed “Nontaxable” to “Tax de-
ferred” when discussing the tax consequences of con-
tributing appreciated property to the various entities.
∙ Updated URL in Taxes in the Real World titled
­Comparing Entities Selected.
∙ Shortened the fact pattern in problem 73. The relevant
facts have not changed.
Chapter 16
∙ Updated the discussion on stock option compensation.
∙ Revised Taxes in the Real World for Facebook stock
options.
∙ Updated the compliance section for new year-end filing.
Chapter 17
∙ Updated the Taxes in the Real World saga of
Weatherford.
∙ Updated the material to incorporate the new FASB
rules on disclosures of deferred tax assets and
liabilities.
∙ Updated the Microsoft uncertain tax benefit footnote
disclosure.
∙ Updated the FASB’s projects involving accounting
for income taxes.
Chapter 18
∙ Edited key facts summary of earnings and profits
(E&P) calculation.
∙ Edited discussion of effect of distributions on E&P.
 ∙ Streamlined and edited discussion of effect of
­noncash property distributions and the effect of
these distributions on taxable income and E&P.
∙ Clarified examples of effect of distributions on
E&P.
Chapter 19
∙ Clarified facts in Example 19-25.
∙ Clarified facts in Comprehensive Problems 19-58
and 19-59.
Chapter 20
∙ Added new Taxes in the Real World box in passive
losses discussion.
∙ Clarified the definition of material participant for
passive loss purposes.
∙ Clarified new partnership tax return due date.
∙ Clarified the connection between 704(b) capital
­accounts and partnership agreements.
Chapter 21
∙ Clarified the explanation of disproportionate distribu-
tions to be more consistent with the §751(b) proposed
regulations.
∙ Clarified the problem illustrating disproportionate
distributions to be more consistent with the §751(b)
proposed regulations.
∙ Clarified the explanation of special basis adjustments
applicable to distributions.
As We Go to Press
The 2018 Edition is current through February 21, 2017. You can visit the
Connect Library for updates that occur after this date.
Chapter 22
∙ Revised discussion of the family member rules for pur-
poses of the S corporation qualification requirements.
∙ Revised discussion of the excess passive investment
income rules.
∙ Updated Social Security Tax wage base for 2017.
∙ Updated tax forms from 2015 to 2016 forms.
Chapter 23
∙ Updated Exhibit 23-4.
∙ Updated Taxes in the Real World for sourcing receipts.
∙ Updated Taxes in the Real World for apportionment.
Chapter 24
∙ Updated the discussion on the OECD base erosion
and profit-shifting project.
∙ Updated the proposals for international tax reform.
∙ Updated the discussion on inversions.
Chapter 25
∙ Clarified computation for unified credit.
∙ Updated exemption equivalent for inflation adjust-
ment made for 2016.
∙ Revised terminology used for unified credit, which is
now referred to as the “applicable credit.”
∙ Updated tax forms for 2016.
∙ Revised discount factors for changes in the regulations.
∙ Revised ethics problem to focus on what constitutes
an intent to make a gift.
xxiii
 Table of Contents

1 An Introduction to Tax Tax Law Sources 2-9

Legislative Sources: Congress and the
Who Cares about Taxes and Why? 1-2 Constitution 2-11
What Qualifies as a Tax? 1-4 Internal Revenue Code 2-11
How to Calculate a Tax 1-5 The Legislative Process for Tax Laws 2-12
Different Ways to Measure Tax Rates 1-5 Basic Organization of the Code 2-13
Tax Treaties 2-14
Tax Rate Structures 1-9
Judicial Sources: The Courts 2-14
Proportional Tax Rate Structure 1-9
Administrative Sources: The U.S. Treasury 2-15
Progressive Tax Rate Structure 1-9
Regulations, Revenue Rulings, and Revenue
Regressive Tax Rate Structure 1-10
Procedures 2-15
Types of Taxes 1-11 Letter Rulings 2-16
Federal Taxes 1-11
Tax Research 2-17
Income Tax 1-12
Step 1: Understand Facts 2-17
Employment and Unemployment Taxes 1-12
Step 2: Identify Issues 2-17
Excise Taxes 1-13
Step 3: Locate Relevant Authorities 2-18
Transfer Taxes 1-13
Step 4: Analyze Tax Authorities 2-19
State and Local Taxes 1-14
Step 5: Document and Communicate the
Income Taxes 1-14 Results 2-21
Sales and Use Taxes 1-14 Facts 2-21
Property Taxes 1-15 Issues 2-21
Excise Taxes 1-15 Authorities 2-22
Implicit Taxes 1-16 Conclusion 2-22
Evaluating Alternative Tax Systems 1-17 Analysis 2-22
Sufficiency 1-18 Client Letters 2-22
Static versus Dynamic Forecasting 1-18 Research Question and Limitations 2-22
Income versus Substitution Effects 1-19 Facts 2-22
Equity 1-20 Analysis 2-22
Horizontal versus Vertical Equity 1-21 Closing 2-22
Certainty 1-22 Tax Professional Responsibilities 2-23
Convenience 1-22
Taxpayer and Tax Practitioner Penalties 2-26
Economy 1-22
Conclusion 2-28
Evaluating Tax Systems—The Trade-Off 1-23
Conclusion 1-23
3 Tax Planning Strategies and Related
Limitations
2 Tax Compliance, the IRS, and Tax
Basic Tax Planning Overview 3-2
Authorities
Timing Strategies 3-2
Taxpayer Filing Requirements 2-2
Present Value of Money 3-3
Tax Return Due Date and Extensions 2-3
The Timing Strategy When Tax Rates Are
Statute of Limitations 2-3 Constant 3-4
IRS Audit Selection 2-4 The Timing Strategy When Tax Rates
Types of Audits 2-5 Change 3-7
After the Audit 2-6 Limitations to Timing Strategies 3-10

xxiv
 Table of Contents xxv

Income-Shifting Strategies 3-11 5 Gross Income and Exclusions

Transactions between Family Members and
Limitations 3-11 Realization and Recognition of Income 5-2
What Is Included in Gross Income? 5-2
Transactions between Owners and Their
Businesses and Limitations 3-12 Economic Benefit 5-3
Income Shifting across Jurisdictions and Realization Principle 5-3
Limitations 3-15 Recognition 5-4
Conversion Strategies 3-16 Other Income Concepts 5-4
Limitations of Conversion Strategies 3-19 Form of Receipt 5-4
Return of Capital Principle 5-4
Additional Limitations to Tax Planning Strategies:
Judicial Doctrines 3-19 Recovery of Amounts Previously
Deducted 5-5
Tax Avoidance versus Tax Evasion 3-20
When Do Taxpayers Recognize Income? 5-6
Conclusion 3-21 Accounting Methods 5-6
Constructive Receipt 5-7
Claim of Right 5-7
4 Individual Income Tax Overview, Who Recognizes the Income? 5-8
Exemptions, and Filing Status Assignment of Income 5-8
The Individual Income Tax Formula 4-2 Community Property Systems 5-8
Gross Income 4-2 Types of Income 5-9
Character of Income 4-5 Income from Services 5-10
Deductions 4-7 Income from Property 5-10
For AGI Deductions 4-7 Annuities 5-11
From AGI Deductions 4-8 Property Dispositions 5-13
Income Tax Calculation 4-10 Other Sources of Gross Income 5-14
Other Taxes 4-10 Income from Flow-Through Entities 5-14
Tax Credits 4-11 Alimony 5-14
Tax Prepayments 4-11 Prizes, Awards, and Gambling
Winnings 5-16
Personal and Dependency Exemptions 4-12
Social Security Benefits 5-17
Dependency Requirements 4-12
Imputed Income 5-19
Qualifying Child 4-12
Discharge of Indebtedness 5-20
Qualifying Relative 4-15
Exclusion Provisions 5-21
Filing Status 4-19
Common Exclusions 5-21
Married Filing Jointly and Married Filing
Municipal Interest 5-21
Separately 4-19
Gains on the Sale of Personal
Qualifying Widow or Widower (Surviving
Residence 5-22
Spouse) 4-20
Fringe Benefits 5-23
Single 4-21
Education-Related Exclusions 5-25
Head of Household 4-21
Scholarships 5-25
Married Individuals Treated as Unmarried
Other Educational Subsidies 5-25
(Abandoned Spouse) 4-23
U.S. Series EE Bonds 5-26
Summary of Income Tax Formula 4-24
Exclusions That Mitigate Double Taxation 5-26
Conclusion 4-27 Gifts and Inheritances 5-26
Appendix A: Dependency Exemption Flowchart Life Insurance Proceeds 5-27
(Part I and Part II) 4-27 Foreign-Earned Income 5-28
Appendix B: Qualifying Person for Head of Sickness and Injury-Related Exclusions 5-29
Household Filing Status Flowchart 4-29 Workers’ Compensation 5-29
Appendix C: Determination of Filing Status Payments Associated with Personal
Flowchart 4-30 Injury 5-29
xxvi Table of Contents

Health Care Reimbursement 5-30 Miscellaneous Itemized Deductions Subject to

Disability Insurance 5-30
Deferral Provisions 5-31
Income Summary 5-31
Conclusion 5-32
Appendix: 2016 Social Security Worksheet from
Form 1040 5-33
6 Individual Deductions
Deductions for AGI 6-2
Deductions Directly Related to Business
Activities 6-2
Trade or Business Expenses 6-4
Rental and Royalty Expenses 6-5
Losses 6-6
Flow-Through Entities 6-6
Deductions Indirectly Related to Business
Activities 6-6
Moving Expenses 6-6
Health Insurance Deduction by Self-
Employed Taxpayers 6-8
Self-Employment Tax Deduction 6-9
Penalty for Early Withdrawal of
Savings 6-9
Deductions Subsidizing Specific
Activities 6-9
Deduction for Interest on Qualified Education
Loans 6-10
Deduction for Qualified Education
Expenses 6-11
Summary: Deductions for AGI 6-12
Deductions from AGI: Itemized
Deductions 6-13
Medical Expenses 6-13
Transportation and Travel for Medical
Purposes 6-15
Hospitals and Long-Term Care
Facilities 6-15
Medical Expense Deduction
Limitation 6-15
Taxes 6-16
Interest 6-17
Charitable Contributions 6-18
Contributions of Money 6-19
Contributions of Property Other Than
Money 6-20
Charitable Contribution Deduction
Limitations 6-21
Casualty and Theft Losses on Personal-Use
Assets 6-23
Tax Loss from Casualties 6-24
Casualty Loss Deduction Floor
Limitations 6-24
AGI Floor 6-26
Employee Business Expenses 6-26
Investment Expenses 6-28
Tax Preparation Fees 6-29
Hobby Losses 6-29
Limitation on Miscellaneous Itemized
Deductions (2 Percent of AGI Floor) 6-31
Miscellaneous Itemized Deductions Not Subject
to AGI Floor 6-31
Phase-Out of Itemized Deductions 6-32
Summary of Itemized Deductions 6-32
The Standard Deduction and Exemptions 6-34
Standard Deduction 6-34
Bunching Itemized Deductions 6-36
Deduction for Personal and Dependency
Exemptions 6-36
Taxable Income Summary 6-37
Conclusion 6-38
Appendix A: Calculation of Itemized Deduction
Phase-Out for 2017 6-38
Appendix B: Personal Exemption Phase-Out
Computation for 2017 6-39
7 Investments
Investments Overview 7-2
Portfolio Income: Interest and Dividends 7-2
Interest 7-3
Corporate and U.S. Treasury Bonds 7-3
U.S. Savings Bonds 7-4
Dividends 7-6
Portfolio Income: Capital Gains and Losses 7-7
Types of Capital Gains and Losses 7-10
25 Percent Gains 7-10
28 Percent Gains 7-10
Netting Process for Gains and Losses 7-12
Calculating Tax Liability on Net Capital
Gains 7-16
Limitations on Capital Losses 7-21
Losses on the Sale of Personal-Use
Assets 7-21
Capital Losses on Sales to Related
Parties 7-22
Wash Sales 7-22
Balancing Tax Planning Strategies for Capital
Assets with Other Goals 7-23
Portfolio Income Summary 7-25
Portfolio Investment Expenses 7-25
Investment Expenses 7-25
Investment Interest Expense 7-26
Net Investment Income 7-27
Net Investment Income Tax 7-29
 Table of Contents xxvii

Passive Activity Income and Losses 7-29 Filing Requirements 8-38

Passive Activity Definition 7-30
Income and Loss Categories 7-31
Rental Real Estate Exception to the Passive
Activity Loss Rules 7-33
Net Investment Income Tax on Net Passive
Income 7-34
Conclusion 7-34
8 Individual Income Tax Computation
and Tax Credits
Regular Federal Income Tax Computation 8-2
Tax Rate Schedules 8-2
Marriage Penalty or Benefit 8-3
Exceptions to the Basic Tax Computation 8-3
Preferential Tax Rates for Capital Gains and
Dividends 8-4
Net Investment Income Tax 8-5
Kiddie Tax 8-6
Alternative Minimum Tax 8-8
Alternative Minimum Tax Formula 8-9
Alternative Minimum Taxable Income
(AMTI) 8-9
AMT Exemption 8-12
Tentative Minimum Tax and AMT
Computation 8-13
General AMT Planning
Strategies 8-14
Employment and Self-Employment
Taxes 8-14
Employee FICA Taxes Payable 8-15
Self-Employment Taxes 8-17
Employee vs. Self-Employed (Independent
Contractor) 8-22
Employee vs. Independent Contractor
Comparison 8-22
Tax Credits 8-24
Nonrefundable Personal Credits 8-25
Child Tax Credit 8-25
Child and Dependent Care Credit 8-26
Education Credits 8-28
Refundable Personal Credits 8-31
Earned Income Credit 8-31
Other Refundable Personal Credits 8-32
Business Tax Credits 8-33
Foreign Tax Credit 8-33
Tax Credit Summary 8-34
Credit Application Sequence 8-34
Taxpayer Prepayments and Filing
Requirements 8-35
Prepayments 8-36
Underpayment Penalties 8-36
Late Filing Penalty 8-38
Late Payment Penalty 8-39
Tax Summary 8-39
Conclusion 8-41
9 Business Income, Deductions,
and Accounting Methods
Business Gross Income 9-2
Business Deductions 9-2
Ordinary and Necessary 9-3
Reasonable in Amount 9-4
Limitations on Business Deductions 9-5
Expenditures against Public Policy 9-5
Political Contributions and Lobbying Costs 9-5
Capital Expenditures 9-6
Expenses Associated with the Production of Tax-
Exempt Income 9-6
Personal Expenditures 9-7
Mixed-Motive Expenditures 9-8
Meals and Entertainment 9-8
Travel and Transportation 9-9
Property Use 9-11
Record Keeping and Other
Requirements 9-11
Specific Business Deductions 9-12
Domestic Production Activities Deduction 9-12
Losses on Dispositions of Business
Property 9-13
Business Casualty Losses 9-14
Accounting Periods 9-15
Accounting Methods 9-16
Financial and Tax Accounting Methods 9-17
Overall Accounting Method 9-17
Cash Method 9-17
Accrual Method 9-18
Accrual Income 9-19
All-Events Test for Income 9-19
Taxation of Advance Payments of Income
(Unearned Income) 9-19
Unearned Service Revenue 9-20
Advance Payment for Goods 9-20
Inventories 9-21
Uniform Capitalization 9-21
Inventory Cost-Flow Methods 9-22
Accrual Deductions 9-24
All-Events Test for Deductions 9-24
Economic Performance 9-24
Bad Debt Expense 9-27
Limitations on Accruals to Related
Parties 9-28
xxviii Table of Contents
Comparison of Accrual and Cash
Methods 9-29
Adopting an Accounting Method 9-30
Changing Accounting Methods 9-33
Tax Consequences of Changing Accounting
Methods 9-33
Conclusion 9-34
10 Property Acquisition and Cost
Recovery
Cost Recovery and Basis for Cost Recovery 10-2
Basis for Cost Recovery 10-3
Depreciation 10-6
Personal Property Depreciation 10-7
Depreciation Method 10-7
Depreciation Recovery Period 10-8
Depreciation Conventions 10-9
Calculating Depreciation for Personal
Property 10-9
Applying the Half-Year Convention 10-10
Applying the Mid-Quarter Convention 10-13
Real Property 10-16
Applicable Method 10-17
Applicable Convention 10-17
Depreciation Tables 10-17
Special Rules Relating to Cost Recovery 10-18
Immediate Expensing 10-18
Listed Property 10-24
Luxury Automobiles 10-26
Depreciation for the Alternative Minimum
Tax 10-29
Depreciation Summary 10-29
Amortization 10-31
Section 197 Intangibles 10-31
Organizational Expenditures and Start-Up
Costs 10-32
Research and Experimentation
Expenditures 10-35
Patents and Copyrights 10-35
Amortizable Intangible Asset Summary 10-36
Depletion 10-37
Conclusion 10-39
Appendix: MACRS Tables 10-40
11 Property Dispositions
Dispositions 11-2
Amount Realized 11-2
Determination of Adjusted Basis 11-3
Gifts 11-3
Inherited Property 11-3
Property Converted from Personal Use to
Business Use 11-3
Realized Gain or Loss on Disposition 11-5
Recognized Gain or Loss on Disposition 11-6
Character of Gain or Loss 11-6
Ordinary Assets 11-7
Capital Assets 11-7
§1231 Assets 11-8
Depreciation Recapture 11-9
§1245 Property 11-10
Scenario 1: Gain Created Solely through Cost
Recovery Deductions 11-11
Scenario 2: Gain Due to Both Cost
Recovery Deductions and Asset
Appreciation 11-11
Scenario 3: Asset Sold at a Loss 11-12
§1250 Depreciation Recapture for Real
Property 11-13
Other Provisions Affecting the Rate at Which Gains
Are Taxed 11-14
Unrecaptured §1250 Gain for Individuals 11-14
Characterizing Gains on the Sale of Depreciable
Property to Related Persons 11-16
Calculating Net §1231 Gains or Losses 11-16
§1231 Look-Back Rule 11-18
Gain or Loss Summary 11-20
Nonrecognition Transactions 11-20
Like-Kind Exchanges 11-20
Definition of Like-Kind Property 11-24
Real Property 11-24
Personal Property 11-24
Property Ineligible for Like-Kind
Treatment 11-25
Property Use 11-25
Timing Requirements for a Like-Kind
Exchange 11-25
Tax Consequences When Like-Kind Property Is
Exchanged Solely for Like-Kind
Property 11-27
Tax Consequences of Transfers Involving Like-
Kind and Non-Like-Kind Property
(Boot) 11-27
Reporting Like-Kind Exchanges 11-29
Involuntary Conversions 11-29
Installment Sales 11-32
Gains Ineligible for Installment
Reporting 11-34
Other Nonrecognition Provisions 11-34
Related-Person Loss Disallowance
Rules 11-35
Conclusion 11-36

12 Compensation
Salary and Wages 12-2
Employee Considerations for Salary and
Wages 12-2
Tax Withholding 12-2
Employer Considerations for Salary and
Wages 12-2
Deductibility of Salary Payments 12-3
Equity-Based Compensation 12-7
Stock Options 12-8
Employee Considerations for Stock
Options 12-10
Employer Considerations for Stock
Options 12-13
Restricted Stock 12-15
Employee Considerations for Restricted
Stock 12-16
Employer Considerations for Restricted
Stock 12-18
Equity-Based Compensation
Summary 12-19
Fringe Benefits 12-19
Taxable Fringe Benefits 12-20
Employee Considerations for Taxable Fringe
Benefits 12-20
Employer Considerations for Taxable Fringe
Benefits 12-22
Nontaxable Fringe Benefits 12-24
Group-Term Life Insurances 12-24
Health and Accident Insurance and
Benefits 12-25
Meals and Lodging for the Convenience of
the Employer 12-25
Employee Educational Assistance 12-26
Dependent Care Benefits 12-26
No-Additional-Cost Services 12-26
Qualified Employee Discounts 12-27
Working Condition Fringe
Benefits 12-28
De Minimis Fringe Benefits 12-28
Qualified Transportation Fringe
Benefits 12-28
Qualified Moving Expense
Reimbursement 12-28
Cafeteria Plans and Flexible Spending
Accounts (FSAs) 12-29
Employee and Employer Considerations for
Nontaxable Fringe Benefits 12-29
Tax Planning with Fringe Benefits 12-30
Fringe Benefits Summary 12-31
Conclusion 12-33
Table of Contents xxix
13 Retirement Savings and Deferred
Compensation
Employer-Provided Qualified Plans 13-3
Defined Benefit Plans 13-3
Vesting 13-4
Distributions 13-5
Nontax Considerations 13-5
Defined Contribution Plans 13-6
Employer Matching 13-6
Contribution Limits 13-7
Vesting 13-7
After-Tax Cost of Contributions to Traditional
(non-Roth) Defined Contribution Plans 13-8
Distributions from Traditional Defined
Contribution Plans 13-9
After-Tax Rates of Return for Traditional Defined
Contribution Plans 13-11
Roth 401(k) Plans 13-11
Comparing Traditional Defined Contribution
Plans and Roth 401(k) Plans 13-14
Nonqualified Deferred Compensation
Plans 13-15
Nonqualified Plans versus Qualified Defined
Contribution Plans 13-15
Employee Considerations 13-16
Employer Considerations 13-18
Individually Managed Qualified Retirement
Plans 13-19
Individual Retirement Accounts 13-19
Traditional IRAs 13-20
Contributions 13-20
Nondeductible Contributions 13-22
Distributions 13-23
Roth IRAs 13-23
Contributions 13-23
Distributions 13-24
Rollover from Traditional to Roth IRA 13-25
Comparing Traditional and Roth IRAs 13-26
Self-Employed Retirement Accounts 13-27
Simplified Employee Pension (SEP)
IRA 13-27
Nontax Considerations 13-28
Individual 401(k) Plans 13-28
Nontax Considerations 13-30
Saver’s Credit 13-30
Conclusion 13-31
Appendix A: Traditional IRA Deduction
Limitations 13-32
Appendix B: Roth IRA Contribution
Limits 13-34
xxx Table of Contents
14 Tax Consequences of Home
Ownership
Personal Use of the Home 14-3
Exclusion of Gain on Sale of Personal
Residence 14-4
Requirements 14-5
Exclusion of Gain from Debt Forgiveness on
Foreclosure of Home Mortgage 14-8
Interest Expense on Home-Related
Debt 14-8
Limitations on Home-Related
Debt 14-9
Mortgage Insurance 14-13
Points 14-13
Real Property Taxes 14-15
Rental Use of the Home 14-17
Residence with Minimal Rental Use 14-17
Residence with Significant Rental Use (Vacation
Home) 14-18
Nonresidence (Rental Property) 14-21
Losses on Rental Property 14-23
Business Use of the Home 14-25
Direct versus Indirect Expenses 14-27
Limitations on Deductibility of Expenses 14-28
Conclusion 14-30
Appendix A: Sample Settlement Statement for the
Jeffersons 14-32
Appendix B: Flowchart of Tax Rules Relating to
Home Used for Rental Purposes 14-34
15 Entities Overview
Entity Legal Classification and Nontax
Characteristics 15-2
Legal Classification 15-2
Nontax Characteristics 15-2
Responsibility for Liabilities 15-3
Rights, Responsibilities, and Legal
Arrangements among Owners 15-3
Entity Tax Classification 15-5
Entity Tax Characteristics 15-7
Double Taxation 15-8
After-Tax Earnings Distributed 15-8
Some or All After-Tax Earnings
Retained 15-11
Mitigating the Double Tax 15-12
Deductibility of Entity Losses 15-14
Other Tax Characteristics 15-15
Converting to Other Entity Types 15-15
Conclusion 15-20
16 Corporate Operations
Corporate Taxable Income Formula 16-2
Accounting Periods and Methods 16-2
Computing Corporate Regular Taxable
Income 16-3
Book–Tax Differences 16-3
Common Permanent Book–Tax
Differences 16-4
Common Temporary Book–Tax
Differences 16-6
Corporate-Specific Deductions and Associated
Book–Tax Differences 16-9
Stock Options 16-9
Net Capital Losses 16-12
Net Operating Losses 16-13
Charitable Contributions 16-15
Dividends Received Deduction 16-18
Taxable Income Summary 16-22
Regular Tax Liability 16-22
Controlled Groups 16-24
Compliance 16-25
Consolidated Tax Returns 16-29
Corporate Tax Return Due Dates and Estimated
Taxes 16-29
Corporate Alternative Minimum Tax 16-33
Preference Items 16-33
Adjustments 16-34
Depreciation Adjustment 16-34
Gain or Loss on Disposition of Depreciable
Assets 16-35
ACE Adjustment 16-35
AMT NOL Deduction (ATNOLD) 16-37
Alternative Minimum Taxable Income
(AMTI) 16-37
AMT Exemption 16-38
Alternative Minimum Tax 16-38
Conclusion 16-39
17 Accounting for Income Taxes
Objectives of Accounting for Income Taxes and the
Income Tax Provision Process 17-2
Why Is Accounting for Income Taxes So
Complex? 17-3
Objectives of ASC 740 17-4
The Income Tax Provision Process 17-6
Calculating the Current and Deferred Income Tax
Expense or Benefit Components of a Company’s
Income Tax Provision 17-6
Step 1: Adjust Pretax Net Income for All
Permanent Differences 17-6

Step 2: Identify All Temporary Differences and
Tax Carryforward Amounts 17-8
Revenues or Gains That Are Taxable after
They Are Recognized in Financial
Income 17-8
Expenses or Losses That Are Deductible
after They Are Recognized in Financial
Income 17-8
Revenues or Gains That Are Taxable before
They Are Recognized in Financial
Income 17-9
Expenses or Losses That Are Deductible
before They Are Recognized in Financial
Income 17-9
Identifying Taxable and Deductible Temporary
Differences 17-9
Taxable Temporary Difference 17-9
Deductible Temporary Difference 17-9
Step 3: Compute the Current Income Tax
Expense or Benefit 17-11
Step 4: Determine the Ending Balances in the
Balance Sheet Deferred Tax Asset and
Liability Accounts 17-12
Determining Whether a Valuation Allowance Is
Needed 17-18
Step 5: Evaluate the Need for a Valuation
Allowance for Gross Deferred Tax
Assets 17-18
Determining the Need for a Valuation
Allowance 17-18
Future Reversals of Existing Taxable
Temporary Differences 17-18
Taxable Income in Prior Carryback Year(s) 17-19
Expected Future Taxable Income Exclusive of
Reversing Temporary Differences and
Carryforwards 17-19
Tax Planning Strategies 17-19
Negative Evidence That a Valuation
Allowance Is Needed 17-19
Step 6: Calculate the Deferred Income Tax
Expense or Benefit 17-22
Accounting for Uncertainty in Income Tax
Positions 17-23
Application of ASC 740 to Uncertain Tax
Positions 17-24
Step 1: Recognition 17-24
Step 2: Measurement 17-24
Subsequent Events 17-26
Interest and Penalties 17-26
Disclosures of Uncertain Tax
Positions 17-27
Schedule UTP (Uncertain Tax Position)
Statement 17-27
Table of Contents xxxi
Financial Statement Disclosure and the
Computation of a Corporation’s Effective Tax
Rate 17-28
Balance Sheet Classification 17-28
Income Tax Footnote Disclosure 17-28
Computation and Reconciliation of the
Income Tax Provision with a Company’s
Hypothetical Tax Provision 17-30
Importance of a Corporation’s Effective Tax
Rate 17-31
Interim Period Effective Tax Rates 17-32
FASB Projects Related to Accounting for Income
Taxes 17-32
Conclusion 17-32
18 Corporate Taxation: Nonliquidating
Distributions
Taxation of Property Distributions 18-2
Determining the Dividend Amount from Earnings
and Profits 18-3
Overview 18-3
Dividends Defined 18-3
Computing Earnings and Profits 18-4
Nontaxable Income Included in Current
E&P 18-4
Deductible Expenses That Do Not Reduce
Current E&P 18-5
Nondeductible Expenses That Reduce
Current E&P 18-5
Items Requiring Separate Accounting
Methods for E&P Purposes 18-5
Ordering of E&P Distributions 18-8
Positive Current E&P and Positive
Accumulated E&P 18-8
Positive Current E&P and Negative
Accumulated E&P 18-8
Negative Current E&P and Positive
Accumulated E&P 18-9
Negative Current E&P and Negative
Accumulated E&P 18-10
Distributions of Noncash Property to
Shareholders 18-11
The Tax Consequences to a Corporation
Paying Noncash Property as a
Dividend 18-12
Liabilities 18-12
Effect of Noncash Property Distributions on
E&P 18-13
Constructive Dividends 18-15
The Motivation to Pay Dividends 18-17
xxxii Table of Contents
Stock Dividends 18-17
Tax Consequences to Shareholders Receiving a
Stock Distribution 18-18
Nontaxable Stock Distributions 18-18
Taxable Stock Distributions 18-18
Stock Redemptions 18-19
The Form of a Stock Redemption 18-20
Redemptions That Reduce a Shareholder’s
Ownership Interest 18-21
Redemptions That Are Substantially
Disproportionate 18-21
Complete Redemption of the Stock Owned
by a Shareholder 18-24
Redemptions That Are Not Essentially
Equivalent to a Dividend 18-25
Tax Consequences to the Distributing
Corporation 18-26
Trends in Stock Redemptions by Publicly Traded
Corporations 18-27
Partial Liquidations 18-28
Conclusion 18-29
19 Corporate Formation, Reorganization,
and Liquidation
Review the Taxation of Property Dispositions 19-2
Tax-Deferred Transfers of Property to a
20 Forming and Operating Partnerships
Corporation 19-4
Transactions Subject to Tax Deferral 19-5
Meeting the Section 351 Tax Deferral
Requirements 19-5
Section 351 Applies Only to the Transfer of
Property to the Corporation 19-5
The Property Transferred to the Corporation
Must Be Exchanged for Stock of the
Corporation 19-6
The Transferor(s) of Property to the
Corporation Must Be in Control, in the
Aggregate, of the Corporation Immediately
after the Transfer 19-6
Tax Consequences to Shareholders 19-9
Tax Consequences When a Shareholder
Receives Boot 19-10
Assumption of Shareholder Liabilities by the
Corporation 19-12
Tax-Avoidance Transactions 19-12
Liabilities in Excess of Basis 19-12
Tax Consequences to the Transferee
Corporation 19-14
Other Issues Related to Incorporating an
Ongoing Business 19-17
Depreciable Assets Transferred to a
Corporation 19-17
Contributions to Capital 19-18
Section 1244 Stock 19-18
Taxable and Tax-Deferred Corporate
Acquisitions 19-20
The Acquisition Tax Model 19-21
Tax Consequences to a Corporate Acquisition 19-22
Taxable Acquisitions 19-23
Tax-Deferred Acquisitions 19-26
Judicial Principles That Underlie All Tax-Deferred
Reorganizations 19-26
Continuity of Interest (COI) 19-26
Continuity of Business Enterprise
(COBE) 19-26
Business Purpose Test 19-27
Type A Asset Acquisitions 19-27
Forward Triangular Type A Merger 19-29
Reverse Triangular Type A Merger 19-29
Type B Stock-for-Stock Reorganizations 19-30
Complete Liquidation of a Corporation 19-33
Tax Consequences to the Shareholders in a
Complete Liquidation 19-34
Tax Consequences to the Liquidating Corporation
in a Complete Liquidation 19-35
Taxable Liquidating Distributions 19-35
Nontaxable Liquidating Distributions 19-38
Conclusion 19-39
Flow-Through Entities Overview 20-2
Aggregate and Entity Concepts 20-2
Partnership Formations and Acquisitions of
Partnership Interests 20-3
Acquiring Partnership Interests When
Partnerships Are Formed 20-3
Contributions of Property 20-3
Contribution of Services 20-9
Organization, Start-Up, and Syndication
Costs 20-12
Acquisitions of Partnership Interests 20-13
Partnership Accounting: Tax Elections, Accounting
Periods, and Accounting Methods 20-13
Tax Elections 20-14
Accounting Periods 20-14
Required Year-Ends 20-14
Accounting Methods 20-16
Reporting the Results of Partnership
Operations 20-17
Ordinary Business Income (Loss) and Separately
Stated Items 20-17
Guaranteed Payments 20-19
Self-Employment Tax 20-20
Net Investment Income Tax 20-22
Allocating Partners’ Shares of Income and
Loss 20-22
Partnership Compliance Issues 20-23
 Table of Contents xxxiii

Partner’s Adjusted Tax Basis in Partnership Operating Issues 22-8

Interest 20-27
Cash Distributions in Operating
Partnerships 20-29
Loss Limitations 20-29
Tax-Basis Limitation 20-29
At-Risk Limitation 20-30
Passive Activity Loss Limitation 20-31
Passive Activity Defined 20-32
Income and Loss Baskets 20-33
Conclusion 20-34
21 Dispositions of Partnership Interests
and Partnership Distributions
Basics of Sales of Partnership Interests 21-2
Seller Issues 21-3
Hot Assets 21-3
Buyer and Partnership Issues 21-7
Varying Interest Rule 21-8
Basics of Partnership Distributions 21-9
Operating Distributions 21-9
Operating Distributions of Money Only 21-9
Operating Distributions That Include Property
Other Than Money 21-10
Liquidating Distributions 21-12
Gain or Loss Recognition in Liquidating
Distributions 21-13
Basis in Distributed Property 21-13
Partner’s Outside Basis Is Greater Than Inside
Basis of Distributed Assets 21-14
Partner’s Outside Basis Is Less Than Inside
Basis of Distributed Assets 21-17
Character and Holding Period of Distributed
Assets 21-21
Disproportionate Distributions 21-24
Special Basis Adjustments 21-26
Special Basis Adjustments for
Dispositions 21-27
Special Basis Adjustments for
Distributions 21-28
Conclusion 21-29
22 S Corporations
S Corporation Elections 22-2
S Corporation Qualification Requirements 22-2
S Corporation Election 22-3
S Corporation Terminations 22-5
Voluntary Terminations 22-5
Involuntary Terminations 22-5
Failure to Meet Requirements 22-5
Excess of Passive Investment Income 22-6
Short Tax Years 22-6
S Corporation Reelections 22-7
Accounting Methods and Periods 22-8
Income and Loss Allocations 22-8
Separately Stated Items 22-9
Shareholder’s Basis 22-11
Initial Basis 22-11
Annual Basis Adjustments 22-12
Loss Limitations 22-13
Tax-Basis Limitation 22-13
At-Risk Limitation 22-14
Post-Termination Transition Period Loss
Limitation 22-14
Passive Activity Loss Limitation 22-15
Self-Employment Income 22-15
3.8 Percent Net Investment Income
Tax 22-16
Fringe Benefits 22-16
Distributions 22-17
Operating Distributions 22-17
S Corporation with No C Corporation
Accumulated Earnings and Profits 22-17
S Corporations with C Corporation
Accumulated Earnings and Profits 22-18
Property Distributions 22-20
Post-Termination Transition Period
Distributions 22-21
Liquidating Distributions 22-21
S Corporation Taxes and Filing
Requirements 22-22
Built-in Gains Tax 22-22
Excess Net Passive Income Tax 22-24
LIFO Recapture Tax 22-26
Estimated Taxes 22-28
Filing Requirements 22-28
Comparing C and S Corporations and
Partnerships 22-30
Conclusion 22-31
23 State and Local Taxes
State and Local Taxes 23-2
Sales and Use Taxes 23-5
Sales and Use Tax Nexus 23-5
Sales and Use Tax Liability 23-7
Income Taxes 23-9
Income Tax Nexus 23-10
Public Law 86-272 23-10
Income Tax Nexus for Other Business Types
or Nonincome-Based Taxes 23-13
Economic Income Tax Nexus 23-13
Entities Included on Income Tax Return 23-15
Separate Tax Returns 23-15
Unitary Tax Returns 23-15
xxxiv Table of Contents

State Taxable Income 23-16 Proposals for Change 24-33

Dividing State Tax Base among States 23-18 Conclusion 24-33
Business Income 23-19
Nonbusiness Income 23-24
State Income Tax Liability 23-24
25 Transfer Taxes and Wealth
Non (Net) Income-Based Taxes 23-25
Planning
Conclusion 23-25 Introduction to Federal Transfer Taxes 25-2
Beginnings 25-2
24 The U.S. Taxation of Multinational Common Features of Integrated Transfer
Taxes 25-2
Transactions
The Federal Gift Tax 25-4
The U.S. Framework for Taxing Multinational Transfers Subject to Gift Tax 25-5
Transactions 24-2
Valuation 25-6
U.S. Taxation of a Nonresident 24-3
The Annual Exclusion 25-8
Definition of a Resident for U.S. Tax
Taxable Gifts 25-9
Purposes 24-4
Gift-Splitting Election 25-10
Overview of the U.S. Foreign Tax Credit
System 24-5 Marital Deduction 25-10
Charitable Deduction 25-12
U.S. Source Rules for Gross Income and
Deductions 24-6 Computation of the Gift Tax 25-12
Source of Income Rules 24-7 Tax on Current Taxable Gifts 25-13
Interest 24-7 Applicable Credit 25-14
Dividends 24-8 The Federal Estate Tax 25-17
Compensation for Services 24-8 The Gross Estate 25-17
Rents and Royalties 24-10 Specific Inclusions 25-18
Gain or Loss from Sale of Real Property 24-10 Valuation 25-21
Gain or Loss from Sale of Purchased Gross Estate Summary 25-22
Personal Property 24-10 The Taxable Estate 25-22
Inventory Produced within the United States Administrative Expenses, Debts, Losses, and
and Sold Outside the United States (§863 State Death Taxes 25-23
Sales) 24-11 Marital and Charitable Deductions 25-23
Source of Deduction Rules 24-12 Computation of the Estate Tax 25-25
General Principles of Allocation and Adjusted Taxable Gifts 25-25
Apportionment 24-12
Applicable Credit 25-26
Special Apportionment Rules 24-13
Wealth Planning Concepts 25-29
Treaties 24-15
The Generation-Skipping Tax 25-29
Foreign Tax Credits 24-20 Income Tax Considerations 25-29
FTC Limitation Categories of Taxable Transfer Tax Planning Techniques 25-30
Income 24-20
Serial Gifts 25-30
Passive Category Income 24-20
The Step-Up in Tax Basis 25-31
General Category Income 24-20
Integrated Wealth Plans 25-32
Creditable Foreign Taxes 24-21
Conclusion 25-33
Direct Taxes 24-22
In Lieu of Taxes 24-22
Appendix A Tax Forms A-1
Indirect (Deemed Paid) Taxes 24-22
Planning for International Operations 24-25 Appendix B Tax Terms Glossary B
Check-the-Box Hybrid Entities 24-26 Appendix C Comprehensive Tax Return
U.S. Anti-Deferral Rules 24-27 Problems C
Definition of a Controlled Foreign Appendix D Tax Rates D
Corporation 24-28
Definition of Subpart F Income 24-29 Code Index CI
Planning to Avoid Subpart F Income 24-31 Subject Index SI-1
 McGraw-Hill’s

Taxation of Individuals
and Business Entities
 chapter

1 An Introduction to Tax

Learning Objectives

Upon completing this chapter, you should be able to:

LO 1-1 Demonstrate how taxes influence basic business, investment, personal, and political
decisions.

LO 1-2 Discuss what constitutes a tax and the general objectives of taxes.

LO 1-3 Describe the different tax rate structures and calculate a tax.

LO 1-4 Identify the various federal, state, and local taxes.

LO 1-5 Apply appropriate criteria to evaluate alternative tax systems.

 Storyline Summary
Taxpayer: Margaret

Employment status:  argaret is a full-time student at

M
the University of Georgia.

Current situation: She is beginning her first

tax class.

© Andrew Rich/Getty Images

M
argaret is a junior beginning her first tax
course. She is excited about her career
prospects as an accounting major but
hasn’t had much exposure to taxes. On her way to
campus she runs into an old friend, Eddy, who is go-
ing to Washington, D.C., to protest recent proposed
changes to the U.S. tax system. Eddy is convinced the
IRS is evil and that the current tax system is blatantly
unfair and corrupt. He advocates a simpler, fairer way
of taxation. Margaret is intrigued by Eddy’s passion
but questions whether he has a complete understand-
ing of the U.S. tax system. She decides to withhold all
judgments about it (or about pursuing a career in
­taxation) until the end of her tax course. ■

1-1
1-2 CHAPTER 1 An Introduction to Tax

LO 1-1 WHO CARES ABOUT TAXES AND WHY?

A clear understanding of the role of taxes in everyday decisions will help you make an
informed decision about the value of studying taxation or pursuing a career in taxa-
tion. One view of taxation is that it represents an inconvenience every April 15th (the
annual due date for filing federal individual tax returns without extensions). However,
the role of taxation is much more pervasive than this view suggests. Your study of this
subject will provide you a unique opportunity to develop an informed opinion about
taxation. As a business student, you can overcome the mystery that encompasses
­popular impressions of the tax system and perhaps, one day, share your expertise with
friends or clients.
What are some common decisions you face that taxes may influence? In this
course, we alert you to situations in which you can increase your return on investments
by up to one-third! Even the best lessons in finance courses can’t approach the in-
crease in risk-adjusted return that smart tax planning provides. Would you like to own
your home someday? Tax deductions for home mortgage interest and real estate taxes
can reduce the after-tax costs of owning a home relative to renting. Thus, when you
face the decision to buy or rent, you can make an informed choice if you understand
the relative tax advantages of home ownership. Would you like to retire someday?
Understanding the tax-advantaged methods of saving for retirement can increase the
after-tax value of your retirement nest egg—and thus increase the likelihood that you
can afford to retire, and do so in style. Other common personal financial decisions that
taxes influence include: choosing investments, evaluating alternative job offers, sav-
ing for education expenses, and doing gift or estate planning. Indeed, taxes are a part
of everyday life and have a significant effect on many of the personal financial
­decisions all of us face.
The role of taxes is not limited to personal finance. Taxes play an equally important
role in fundamental business decisions such as the following:
∙ What organizational form should a business use?
∙ Where should the business locate?
∙ How should business acquisitions be structured?
∙ How should the business compensate employees?
∙ What is the appropriate mix of debt and equity for the business?
∙ Should the business rent or own its equipment and property?
∙ How should the business distribute profits to its owners?
Savvy business decisions require owners and managers to consider all costs and
b­ enefits in order to evaluate the merits of a transaction. Although taxes don’t necessarily
dominate these decisions, they do represent large transaction costs that businesses should
factor into the financial decision-making process.
Taxes also play a major part in the political process. U.S. presidential candidates
­often distinguish themselves from their opponents based upon their tax rhetoric. Indeed,
the major political parties generally have very diverse views of the appropriate way to tax
the public.1 Determining who is taxed, what is taxed, and how much is taxed are tough
questions with nontrivial answers. Voters must have a basic understanding of taxes to
evaluate the merits of alternative tax proposals. Later in this chapter, we’ll introduce
­criteria you can use to evaluate alternative tax proposals.

1
The U.S. Department of the Treasury provides a “history of taxation” on its website (www.treasury.gov/
resource-center/faqs/Taxes/Pages/historyrooseveltmessage.aspx). You may find it interesting to read this
history in light of the various political parties in office at the time.

TAXES IN THE REAL WORLD Republicans vs. Democrats
Tax Policy: Republicans versus Democrats
Oliver Wendell Holmes said “taxes are the price
we pay to live in a civilized society.” Both Demo-
crats and Republicans desire the same things: a
civilized society and a healthy economy. How-
ever, neither party can agree on what defines a
civilized society or which path best leads to a
healthy economy. The U.S. national debt is
$20 trillion dollars and growing, yet the only thing
we might agree on is that something has gone
wrong. Regardless of which party or candidate
you support, each party’s agenda will affect your
income and taxes in various ways.
To explore the divide, let’s examine excerpts
from each party’s National Platform from our most
recent presidential election (2016).
Republicans
“We are the party of a growing economy that
gives everyone a chance in life, an opportunity to
learn, work, and realize the prosperity freedom
makes possible.”
“Government cannot create prosperity,
though government can limit or destroy it. Pros-
perity is the product of self-discipline, enterprise,
saving and investment by individuals, but it is not
an end in itself. Prosperity provides the means by
which citizens and their families can maintain
their independence from government, raise their
children by their own values, practice their faith,
and build communities of cooperation and mu-
tual respect.”
“Republicans consider the establishment of
a pro-growth tax code a moral imperative.
More than any other public policy, the way gov-
ernment raises revenue—how much, at what
rates, under what circumstances, from whom,
and for whom—has the greatest impact on our
economy’s performance. It powerfully influ-
ences the level of economic growth and job
creation, which translates into the level of op-
portunity for those who would otherwise be left
behind.”
“A strong economy is one key to debt reduc-
tion, but spending restraint is a necessary com-
ponent that must be vigorously pursued.” https://
www.gop.com/platform/restoring-the-american-
dream/
In summary, taxes affect many aspects of personal, business, and political decisions.
Developing a solid understanding of taxation should allow you to make informed
­decisions in these areas. Thus, Margaret can take comfort that her semester will likely
prove useful to her personally. Who knows? Depending on her interest in business,
­investment, retirement planning, and the like, she may ultimately decide to pursue a
­career in taxation.
CHAPTER 1 An Introduction to Tax 1-3
Democrats
“At a time of massive income and wealth inequal-
ity, we believe the wealthiest Americans and larg-
est corporations must pay their fair share of
taxes. Democrats will claw back tax breaks for
companies that ship jobs overseas, eliminate tax
breaks for big oil and gas companies, and crack
down on inversions and other methods compa-
nies use to dodge their tax responsibilities … We
will then use the revenue raised from fixing the
corporate tax code to reinvest in rebuilding
America and ensuring economic growth that will
lead to millions of good-paying jobs.”
“We will ensure those at the top contribute to
our country’s future by establishing a multimillion-
aire surtax to ensure millionaires and billionaires
pay their fair share. In addition, we will shut down
the “private tax system” for those at the top, im-
mediately close egregious loopholes like those
enjoyed by hedge fund managers, restore fair
taxation on multimillion dollar estates, and ensure
millionaires can no longer pay a lower rate than
their secretaries. At a time of near-record corpo-
rate profits, slow wage growth, and rising costs,
we need to offer tax relief to middle-class
­families—not those at the top.”
“We will offer tax relief to hard working,­middle-
class families for the cost squeeze they have
faced for years from rising health care, childcare,
education, and other expenses.” https://www
.democrats.org/party-platform#preamble
Conclusion
Each party fundamentally believes the govern-
ment should create/maintain cities and states that
form a civilized society, and that government
should foster a healthy economy. However, they THE KEY FACTS
choose very different paths to reach this objec- What Qualifies
tive. Democrats want to raise taxes on the as a Tax?
wealthy and create government programs which • The general purpose of
cost more money, while Republicans wish to taxes is to fund govern-
lower taxes and decrease government size and ment agencies.
spending. Both motives are pure; however, cur- • Unlike fines or penalties,
rent and cumulative deficits indicate that current taxes are not meant to
revenue is insufficient to meet government punish or prevent illegal
spending. Solving these problems will require behavior; however, “sin
civil discourse, education and research/informa- taxes” are meant to dis-
courage some behaviors.
tion in order to find realistic, effective solutions.
• To qualify as a tax, three
criteria must be met. The
payment must be:
• required;
• imposed by a
government;
• and not tied directly to
the benefit received by
the taxpayer.
1-4 CHAPTER 1 An Introduction to Tax

LO 1-2 WHAT QUALIFIES AS A TAX?

“Taxes are the price we pay for a civilized society.” —Oliver Wendell Holmes, Jr.
Taxes have been described in many terms: some positive, some negative, some
­printable, some not. Let’s go directly to a formal definition of a tax, which should prove
useful in identifying alternative taxes and discussing alternative tax systems.
A tax is a payment required by a government that is unrelated to any specific benefit
or service received from the government. The general purpose of a tax is to fund the
­operations of the government (to raise revenue). Taxes differ from fines and penalties in
that taxes are not intended to punish or prevent illegal behavior. Nonetheless, by allowing
deductions from income, our federal tax system does encourage certain behaviors like
charitable contributions, retirement savings, and research and development. Thus, we
can view it as discouraging other legal behavior. For example, sin taxes impose rela-
tively high surcharges on alcohol and tobacco products.2 Another example is the shared-
responsibility payment introduced by the Affordable Care Act (see the nearby box). This
payment was declared to be a “tax” by the Supreme Court. The tax is imposed on those
who do not have minimum essential health care coverage.3

TAXES IN THE REAL WORLD Affordable Care Act

The Affordable Care Act requires individuals to
be covered by a health insurance plan or to pay
a tax—which is paid on the individual’s income
tax return. The adult annual dollar amount was
phased in as follows: $95 in 2014; $325 in
2015; $695 in 2016 and is indexed by inflation
thereafter. The Congressional Budget Office
and the Joint Committee on Taxation jointly esti-
mated that 5.9 million Americans will be subject
to the penalty in 2016 and the provision will
raise $6.9 billion in revenue in that year.
You may recall that one question the
­Supreme Court had to rule on was whether this
provision is a “penalty” or a “tax.” The Supreme
Court held that the provision is a tax and an-
swered as follows: “The payment is not so high
that there is really no choice but to buy health
insurance; the payment is not limited to willful
­violations, as penalties for unlawful acts often
are; and the payment is collected solely by the
(Internal Revenue Service) through the normal
means of taxation,” Chief Justice John Roberts
wrote in the decision.
Source: National Federation of Independent Business v.
Sebelius, 132 S. Ct. 2566 (2012).

Key components of the definition of a tax are that the payment is:
∙ Required (it is not voluntary);
∙ Imposed by a government agency (federal, state, or local); and
∙ Not tied directly to the benefit received by the taxpayer.
This last point is not to say that taxpayers receive no benefits from the taxes they pay.
They benefit from national defense, a judicial system, law enforcement, government-
sponsored social programs, an interstate highway system, public schools, and many other
government-provided programs and services. The distinction is that taxes paid are not directly
related to any specific benefit received by the taxpayer. For example, the price of admission to
Yellowstone National Park is a fee rather than a tax because a specific benefit is received.
Can taxes be assessed for special purposes, such as a 1 percent sales tax for educa-
tion? Yes. Why is an earmarked tax, a tax that is assessed for a specific purpose, still
considered a tax? Because the payment made by the taxpayer does not directly relate to
the specific benefit received by the taxpayer.

2
Sin taxes represent an interesting confluence of incentives. On the one hand, demand for such products as
alcohol, tobacco, and gambling is often relatively inelastic because of their addictive quality. Thus, taxing
such a product can raise substantial revenues. On the other hand, one of the arguments for sin taxes is fre-
quently the social goal of reducing demand for such products.
3
For details on the computation of the shared-responsibility payment see Reg. §1.5000A-4.
 CHAPTER 1 An Introduction to Tax 1-5

Example 1-1
Margaret travels to Birmingham, Alabama, where she rents a hotel room and dines at several restau-
rants. The price she pays for her hotel room and meals includes an additional 2 percent city surcharge
to fund roadway construction in Birmingham. Is this a tax?
Answer: Yes. The payment is required by a local government and does not directly relate to a specific
benefit that Margaret receives.

Example 1-2
Margaret’s parents, Bill and Mercedes, recently built a house and were assessed $1,000 by their
county government to connect to the county sewer system. Is this a tax?
Answer: No. The assessment was mandatory and it was paid to a local government. However, the
third criterion was not met since the payment directly relates to a specific benefit (sewer service)
­received by the payees. For the same reason, tolls, parking meter fees, and annual licensing fees are
also not considered taxes.

HOW TO CALCULATE A TAX LO 1-3

In its simplest form, the amount of tax equals the tax base multiplied by the tax rate:

Eq. 1-1 Tax = Tax Base × Tax Rate

The tax base defines what is actually taxed and is usually expressed in monetary
terms, whereas the tax rate determines the level of taxes imposed on the tax base and is THE KEY FACTS
usually expressed as a percentage. For example, a sales tax rate of 6 percent on a purchase How to Calculate a Tax
of $30 yields a tax of $1.80 ($1.80 = $30 × .06). • Tax = Tax base × Tax rate
Federal, state, and local jurisdictions use a large variety of tax bases to collect tax. • The tax base defines what
Some common tax bases (and related taxes) include taxable income (federal and state is actually taxed and is
income taxes), purchases (sales tax), real estate values (real estate tax), and personal ­usually expressed in
­monetary terms.
property values (personal property tax).
• The tax rate determines
Different portions of a tax base may be taxed at different rates. A single tax applied the level of taxes imposed
to an entire base constitutes a flat tax. In the case of graduated taxes, the base is divided on the tax base and is
into a series of monetary amounts, or brackets, and each successive bracket is taxed at a usually expressed as a
different (gradually higher or gradually lower) percentage rate. percentage.
Calculating some taxes—income taxes for individuals or corporations, for ­example— • Different portions of a
can be quite complex. Advocates of flat taxes argue that the process should be simpler. But tax base may be taxed
at ­different rates.
as we’ll see throughout the text, most of the difficulty in calculating a tax rests in determin-
ing the tax base, not the tax rate. Indeed, there are only three basic tax rate ­structures (pro-
portional, progressive, and regressive), and each can be mastered without much difficulty.

DIFFERENT WAYS TO MEASURE TAX RATES

Before we discuss the alternative tax rate structures, let’s first define three different tax
rates that will be useful in contrasting the different tax rate structures: the marginal,
­average, and effective tax rates.
The marginal tax rate is the tax rate that applies to the next additional increment of
a taxpayer’s taxable income (or deductions). Specifically,

Marginal Tax Rate =

ΔTax* (New Total Tax − Old Total Tax)
Eq. 1-2 =
ΔTaxable Income (New Taxable Income − Old Taxable Income)
*Δ means change in.
1-6 CHAPTER 1 An Introduction to Tax

where “old” refers to the current tax and “new” refers to the revised tax after incorporat-
ing the additional income (or deductions) in question. In graduated income tax systems,
additional income (deductions) can push a taxpayer into a higher (lower) tax bracket, thus
changing the marginal tax rate.

Example 1-3
Margaret’s parents, Bill and Mercedes, file a joint tax return. They have $160,000 of taxable income
this year (after all tax deductions). Assuming the following federal tax rate schedule applies, how much
federal income tax will they owe this year?4

Married Filing Jointly (and Surviving Spouses)

Not over $18,650 10% of taxable income

$18,650 to $75,900 $1,865 + 15% of taxable income in excess of $18,650
$75,900 to $153,100 $10,462.50 + 25% of taxable income in excess of $75,900
$153,100 to $233,350 $29,752.50 + 28% of taxable income in excess of $153,100
$233,350 to $416,700 $52,222.50 + 33% of taxable income in excess of $233,350
$416,700 to $470,700 $112,728 + 35% of taxable income in excess of $416,700
Over $470,700 $131,628 + 39.6% of taxable income in excess of $470,700

Answer: Bill and Mercedes will owe $31,684.50 computed as follows:

$31,684.50 = $29,752.50 + 28% ($160,000 − $153,100)

Note that in this graduated tax rate structure, the first $18,650 of taxable income is
taxed at 10 percent, the next $57,250 of taxable income (between $18,650 and $75,900)
is taxed at 15 percent, and the next $77,200 of taxable income (between $75,900 and
$153,100) is taxed at 25 percent. Bill and Mercedes’s last $6,900 of taxable income
­(between $153,100 and $160,000) is taxed at 28 percent.
Many taxpayers incorrectly believe that all their income is taxed at their marginal rate.
This mistake leads people to say, “I don’t want to earn any additional money because it
will put me in a higher tax bracket.” Bill and Mercedes are currently in the 28 percent
marginal tax rate bracket, but notice that not all their income is taxed at this rate. Their
marginal tax rate is 28 percent. This means that small increases in income will be taxed at
28 percent, and small increases in tax deductions will generate tax savings of 28 percent.
If Bill and Mercedes receive a large increase in income (or in deductions) such that they
would change tax rate brackets, we cannot identify their marginal tax rate by simply
­identifying their current tax bracket.

Example 1-4
Bill, a well-known economics professor, signs a publishing contract with an $80,000 royalty advance.
Using the rate schedule from Example 1-3, what would Bill and Mercedes’s marginal tax rate be on this
additional $80,000 of taxable income?
Answer: 28.42 percent, computed as follows:

Description Amount Explanation

(1) Taxable income with additional $240,000.00 $80,000 plus $160,000 taxable income
$80,000 of taxable income (Example 1-3)
(2) Tax on $240,000 taxable income $ 54,417.00 Using the rate schedule in Example 1-3,
$54,417.00 = $52,222.50 + 33% ×
($240,000 − $233,350)

4
The tax rate schedules for single, married filing jointly, married filing separately, and head of household are
included in Appendix D.
 CHAPTER 1 An Introduction to Tax 1-7

Description Amount Explanation

(3) Taxable income before additional $160,000.00 Example 1-3

$80,000 of taxable income
(4) Tax on $160,000 taxable income $ 31,684.50 Example 1-3
ΔTax
Marginal tax rate on additional 28.42% = [ (2) − (4)]∕[ (1) − (3)]
ΔTaxable income
$80,000 of taxable income

Note that Bill and Mercedes’s marginal tax rate on the $80,000 increase in taxable income rests
­between the 28 percent and 33 percent bracket rates because a portion of the additional
­income ($233,350 − $160,000 = $73,350) is taxed at 28 percent with the remaining income
($240,000 − $233,350 = $6,650) taxed at 33 percent.

Example 1-5
Assume now that, instead of receiving a book advance, Bill and Mercedes start a new business that
loses $60,000 this year (it results in $60,000 of additional tax deductions). What would be their
­marginal tax rate for these deductions?
Answer: 25.26 percent, computed as follows:

Description Amount Explanation

(1) Taxable income with additional $100,000.00 $160,000 taxable income

$60,000 of tax deductions (Example 1-3) less $60,000
(2) Tax on $100,000 taxable income $ 16,487.50 Using the rate schedule in Example 1-3,
$100,000 − $75,900 = $24,100 × 25%
= $6,025 + $10,462.50
(3) Taxable income before additional $160,000.00 Example 1-3
THE KEY FACTS
$60,000 of tax deductions Different Ways to
Measure Tax Rates
(4) Tax on $160,000 taxable income $ 31,684.50 Example 1-3
• Marginal tax rate
ΔTax
Marginal tax rate on additional 25.33% = [ (2)− (4)]∕[ (1) − (3)] • The tax that applies to
ΔTaxable income
$60,000 of tax deductions the next increment of
income or deduction.
ΔTax
Bill and Mercedes’s marginal tax rate on $60,000 of additional deductions (25.33 percent) differs • =
ΔTaxable income
from their marginal tax rate on $80,000 of additional taxable income (28.42 percent) in these scenar- • Useful in tax planning.
ios because the relatively large increase in deductions in Example 1-5 causes some of their income to
• Average tax rate
be taxed in a lower tax rate bracket, while the relatively large increase in income in Example 1-4
• A taxpayer’s average
causes some of their income to be taxed in a higher tax rate bracket. Taxpayers often will face the
level of taxation on each
same ­marginal tax rates for small changes in income and deductions.
dollar of taxable income.
Total tax
• =
Taxable income
• Useful in budgeting tax
The marginal tax rate is particularly useful in tax planning because it represents the expense.
rate of taxation or savings that would apply to additional taxable income (or tax deduc- • Effective tax rate
tions). In the Tax Planning Strategies and Related Limitations chapter, we discuss basic • A taxpayer’s average
tax planning strategies that use the marginal tax rate. rate of taxation on each
The average tax rate represents a taxpayer’s average level of taxation on each dollar dollar of total income
of taxable income. Specifically, (taxable and nontaxable
income).
Total Tax • =
Total tax
Eq. 1-3 Average Tax Rate = Total income
Taxable Income • Useful in comparing the
relative tax burdens of
The average tax rate is often used in budgeting tax expense as a portion of income (i.e, taxpayers.
determining what percent of taxable income earned is paid in tax).
1-8 CHAPTER 1 An Introduction to Tax

The effective tax rate represents the taxpayer’s average rate of taxation on each
d­ ollar of total income (sometimes referred to as economic income), including taxable and
nontaxable income. Specifically,

Total Tax
Eq. 1-4 Effective Tax Rate =
Total Income

Relative to the average tax rate, the effective tax rate provides a better depiction of a tax-
payer’s tax burden because it depicts the taxpayer’s total tax paid as a ratio of the sum of
both taxable and nontaxable income earned.

Example 1-6
Assuming Bill and Mercedes have $160,000 of taxable income and $10,000 of nontaxable income,
what is their average tax rate?
Answer: 19.80 percent, computed as follows:

Description Amount Explanation

(1) Taxable income $160,000.00

(2) Tax on $160,000 taxable income $ 31,684.50 Example 1-3
Total tax
Average tax rate 19.80% = (2)∕(1)
Taxable income

We should not be surprised that Bill and Mercedes’s average tax rate is lower than
their marginal tax rate because, although they are currently in the 28 percent tax rate
bracket, not all of their taxable income is subject to tax at 28 percent. The first $18,650
of their taxable income is taxed at 10 percent, their next $57,250 is taxed at 15 per-
cent, their next $77,200 is taxed at 25 percent, and only their last $6,900 of taxable
income is taxed at 28 percent. Thus, their average tax rate is considerably lower than
their marginal tax rate.

Example 1-7
Again, given the same income figures as in Example 1-6 ($160,000 of taxable income and $10,000 of
nontaxable income), what is Bill and Mercedes’s effective tax rate?
Answer: 18.64 percent, computed as follows:

Description Amount Explanation

(1) Total income $170,000.00 $160,000 taxable income plus

$10,000 in nontaxable income
(Example 1-6)
(2) Tax on $160,000 taxable income $ 31,684.50 Example 1-3
Total tax
Effective tax rate 18.64% = (2)∕(1)
Total income

Should we be surprised that the effective tax rate is lower than the average tax rate?
No, because except when the taxpayer has more nondeductible expenses (such as fines or
penalties) than nontaxable income (such as tax-exempt interest), the effective tax rate will
be equal to or less than the average tax rate.
Another random document with
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 This mystical error is distinctly characterized in the first chapter of
this gospel, and is there met by the direct assertions, that in Jesus
Christ, the Word, and the God, was not only life, but that the life
itself was the light of men;――and that John the Baptist “was not
the Light, but was only sent to bear witness of the Light;” and
again, with all the tautological earnestness of an old man, the aged
writer repeats the assertion that “this was the true Light, which
enlightens every man that comes into the world.” Against these
same sectaries, the greater part of the first chapter is directed
distinctly, and the whole tendency of the work throughout, is in a
marked manner opposed to their views. With them too, John had
had a local connection, by his residence in Ephesus, where, as it is
distinctly specified in the Acts of the Apostles, Paul had found the
peculiar disciples of John the Baptist long before, on his first visit to
that city; and had successfully preached to some of them, the
religion of Christ, which before was a strange and new thing to them.
The whole tendency and scope of this gospel, indeed, as directed
against these two prominent classes of heretics, both Gnostics and
Sabians, are fully and distinctly summed up in the conclusion of the
twentieth chapter;――“These things are written, that ye might
believe that Jesus is the Christ, the Son of God, and that in
believing on him, ye might have life through his name.”

As to the place where this gospel was written, there is a very

decided difference of opinion among high authorities, both ancient
and modern,――some affirming it to have been composed in
Patmos, during his exile, and others in Ephesus, before or after his
banishment. The best authority, however, seems to decide in favor of
Ephesus, as the place; and this view seems to be most generally
adopted in modern times. Even those who suppose it to have been
written in Patmos, however, grant that it was first given to the
Christian world in Ephesus,――the weight of early authority being
very decided on this latter point. This distinction between the place of
composition and the place of publication, is certainly very reasonable
on some accounts, and is supported by ancient authorities of
dubious date; but there are important objections to the idea of the
composition of both this and the Apocalypse, in the same place,
during about one year, which was the period of his exile. There seem
to be many things in the style of the gospel which would show it to
be a work written at a different period, and under different
circumstances from the Apocalypse; and some Biblical critics, of
high standing, have thought that the gospel bore marks in its style,
which characterized it as a production of a much older man than the
author of the energetic, and almost furious denunciations of the
Apocalypse, must have been. In this case, where ancient authority is
so little decisive, it is but fair to leave the point to be determined by
evidence thus connected with the date, and drawn from the internal
character of the composition itself,――a sort of evidence, on which
the latest moderns are far more capable of deciding than the most
ancient, and the sagest of the Fathers. The date itself is of course
inseparably connected with the determination of the place, and like
that, must be pronounced very uncertain. The greatest probability
about both these points is, that it was written at Ephesus, after his
return from Patmos; for the idea of its being produced before his
banishment, during his first residence in Asia, has long ago been
exploded; nor is there any late writer of authority on these points,
who pretends to support this unfounded notion.

his first epistle.

All that has been said on the character and the objects of the
gospel, may be exactly applied to this very similar production. So
completely does it resemble John’s gospel, in style, language,
doctrines and tendencies, that even a superficial reader might be
ready to pronounce, on a common examination, that they were
written in the same circumstances and with the same object. This
has been the conclusion at which the most learned critics have
arrived, after a full investigation of the peculiarities of both,
throughout; and the standard opinion now is, that they were both
written at the same time and for the same persons. Some reasons
have been given by high critical authority, for supposing that they
were both written at Patmos, and sent together to Ephesus,――the
epistle serving as a preface, dedication, and accompaniment of the
gospel, to those for whom it was intended, and commending the
prominent points in it to their particular attention. This beautiful and
satisfactory view of the object and occasion of the epistle, may
certainly be adopted with great propriety and justice; but in regard to
the places of its composition and direction, a different view is much
more probable, as well as more consistent with the notion, already
presented above, of the date and place of the gospel. It is very
reasonable to suppose that the epistle was written some years after
John’s return to Ephesus,――that it was intended, (along with the
gospel, for the churches of Asia generally, to whom John hoped to
make an apostolic pastoral visit, shortly,) to confirm them in the faith,
as he announces in the conclusion. There is not a single
circumstance in gospel or epistle, which should lead any one to
believe that they were directed to Ephesus in particular. On the
contrary, the total absence of anything like a personal or local
direction to the epistle, shows the justice of its common title, that it is
a “general epistle,” a circular, in short, to all the churches under his
special apostolic supervision,――for whose particular dangers,
errors and necessities, he had written the gospel just sent forth, and
to whom he now minutely commended that work, in the very opening
words of his letter, referring as palpably and undeniably to his
gospel, as any words can express. “Of that which ‘was from the
beginning, of the Word,’ which I have heard, which I have seen with
my eyes, which I have looked upon, which my hands have
handled,――of the Word of Life” &c.; particularizing with all the
minute verbosity of old age, his exact knowledge of the facts which
he gives in his gospel, assuring them thus of the accuracy of his
descriptions. The question concerns his reputation for fidelity as a
historian; and it is easy to see therefore, why he should labor thus to
impress on his readers his important personal advantages for
knowing exactly all the facts he treats of, and all the doctrines which
he gives at such length in the discourses of Christ. Again and again
he says, “I write,” and “I have written,” recapitulating the sum of the
doctrines which he has designed to inculcate; and he particularizes
still farther that he has written to all classes and ages, from the
oldest to the youngest, intending his gospel for the benefit of all. “I
have written to you, fathers,”――“unto you, young men,”――“unto
you, little children,” &c. What else can this imply, than a dedication of
the work concerning “the WORD,” to all stations and ages,――to the
whole of the Christian communities, to whom he commits and
recommends his writings;――as he writes “to the
fathers――because they know him who was from the
beginning,”――in the same way “to the young men, because they
are constant, and the Word of God dwells in them,” and “that the
doctrine they have received may remain unchangeable in them,” and
“on account of those who would seduce them.” He recapitulates
all the leading doctrines of his gospel,――the Messiahship, and the
Divinity of Jesus,――his Unity, and identity with the divine
abstractions of the Gnostic theology. Here too, he inculcates and
renewedly urges the great feeling of Christian brotherly love, which
so decidedly characterizes the discourses of Jesus, as reported in
his gospel. So perfect was the connection of origin and design,
between the gospel and this accompanying letter, that they were
anciently placed together, the epistle immediately following the
gospel; as is indubitably proved by certain marks in ancient
manuscripts.

It was mentioned, in connection with a former part of John’s life, that this epistle is
quoted by Augustin and others, under the title of the epistle to the Parthians. It seems very
probable that this may have been also addressed to those churches in the east, about
Babylon, which had certainly suffered much under the attacks of these same mystical
heretics. It is explained, however, by some, that this was an accidental corruption in the
copying of the Greek.――The second epistle was quoted by Clemens Alexandrinus, under
the title of “the epistle to the virgins,” προς παρθενους, which, as some of the modern critics
say, must have been accidentally changed to παρθους, by dropping some of the syllables,
and afterwards transferred to the first (!) as more appropriate;――a perfectly unauthorized
conjecture, and directly in the face of all rules of criticism.

the second and third epistles.

These are both evidently private letters from John to two of his
intimate personal friends, of whose circumstances nothing whatever
being known, except what is therein contained, the notice of these
brief writings must necessarily be brief also. They are both honorably
referred to, as entertainers of the servants of Jesus Christ as they
travel from place to place, and seem to have been residents in some
of the Asian cities within John’s apostolic circuit, and probably
received him kindly and reverently into their houses on his tours of
duty; and them he was about to visit again shortly. The second
epistle is directed to a Christian female, who, being designated by
the very honorable title of “lady,” was evidently a person of rank; and
from the remark towards the conclusion, about the proper objects of
her hospitality, it is plain that she must have been also a person of
some property. Mention is made of her children as also objects of
warm affection to the aged apostle; and as no other member of her
family is noticed, it is reasonable to conclude that she was a widow.
The contents of this short letter are a mere transcript, almost
verbatim, of some important points in the first, inculcating Christian
love, and watchfulness against deceivers;――(no doubt the
Gnostical heretics,――the Cerinthians and Nicolaitans.) He
apologizes for the shortness of the letter, by saying that he hopes
shortly to visit her; and ends by communicating the affectionate
greetings of her sister’s children, then residents in Ephesus, or
whatever city was then the home of John. The third epistle is
directed to Gaius, (that is, Caius, a Roman name,) whose hospitality
is commemorated with great particularity and gratitude in behalf of
Christian strangers, probably preachers, traveling in his region.
Another person, named Diotrephes, (a Greek by name, and probably
one of the partizans of Cerinthus,) is mentioned as maintaining a
very different character, who, so far from receiving the ministers of
the gospel sent by the apostle, had even excluded from Christian
fellowship those who did exercise this hospitality to the messengers
of the apostle. John speaks threateningly of him, and closes with the
same apology for the shortness of the letter, as in the former. There
are several persons, named Gaius, or Caius, mentioned in apostolic
history; but there is no reason to suppose that any of them was
identified with this man.

For these lucid views of the objects of all these epistles, I am mainly indebted to Hug’s
Introduction, to whom belongs the merit of expressing them in this distinctness, though
others before him have not been far from apprehending their simple force. Michaelis, for
instance, is very satisfactory, and much more full on some points. In respect to the place
whence they were written, Hug appears to be wholly in the wrong, in referring them to
Patmos, just before John’s return. Not the least glimmer of a reason appears, why all the
writings of John should be huddled together in his exile. I can make nothing whatever of the
learned commentator’s reason about the deficiency of “pen, ink and paper,” (mentioned in
Epistle ii. 12, and iii. 13.) as showing that John must still have been in “that miserable
place,” Patmos. The idea seems to require a great perversion of simple words, which do not
seem to be capable of any other sense than that adopted in the above account.

the traditions of his life in ephesus.

To this period of his life, are referred those stories of his miracles
and actions, with which the ancient fictitious apostolic narratives are
so crowded,――John being the subject of more ancient traditions
than any other apostle. Some of those are so respectable and
reasonable in their character, as to deserve a place here, although
none of them are of such antiquity as to deserve any confidence, on
points where fiction has often been so busy. The first which follows,
is altogether the most ancient of all apostolic stories, which are not in
the New Testament; and even if it is a work of fiction, it has such
merits as a mere tale, that it would be injustice to the readers of this
book, not to give them the whole story, from the most ancient and
best authorized record.

It is related that John, after returning from banishment, was often

called to the neighboring churches to organize them, or to heal
divisions, and to ordain elders. On one occasion, after ordaining a
bishop, he committed to his particular care and instruction a fine
young man, whom he saw in the congregation, charging the bishop,
before the whole church, to be faithful to him. The bishop accordingly
took the young man into his house, watched over him, and instructed
him, and at length baptized him. After this, viewing the young man as
a confirmed Christian, the bishop relaxed his watchfulness, and
allowed the youth greater liberties. He soon got into bad company, in
which his talents made him conspicuous, and proceeding from one
step to another, he finally became the leader of a band of robbers. In
this state of things, John came to visit the church, and presently
called upon the bishop to bring forward his charge. The bishop
replied that he was dead,――dead to God;――and was now in the
mountains, a captain of banditti. John ordered a horse to be brought
immediately to the church door, and a guide to attend him; and
mounting, he rode full speed in search of the gang. He soon fell in
with some of them, who seized him, to be carried to their head
quarters. John told them that this was just what he wanted, for he
came on purpose to see their captain. As they drew near, the captain
stood ready to receive them; but on seeing John, he drew back, and
began to make off. John pursued with all the speed his aged limbs
would permit, crying out, “My son, why do you run from your own
father, who is unarmed and aged? Pity me, my son, and do not fear.
There is yet hope of your life. I will intercede for you; and, if
necessary, will cheerfully suffer death for you, as the Lord did for us.
Stop,――believe what I say; Christ hath sent me.” The young man
stopped, looked on the ground, and then throwing down his arms,
came trembling, and with sobs and tears, begged for pardon. The
apostle assured him of the forgiveness of Christ; and conducting him
back to the church, there fasted and prayed with him, and at length
procured his absolution.

Another story, far less probable, is related in the ancient

martyrologies, and by the counterfeit Abdias. Craton, a philosopher,
to make a display of contempt for riches, had persuaded two wealthy
young men, his followers, to invest all their property in two very
costly pearls; and then, in the presence of a multitude, to break
them, and pound them to dust. John happening to pass by, at the
close of the transaction, censured this destruction of property, which
might better have been given in alms to the poor. Craton told him, if
he thought so, he might miraculously restore the dust to solid pearls
again, and have them for charitable purposes. The apostle gathered
up the particles, and holding them in his hand, prayed fervently, that
they might become solid pearls, and when the people said “Amen,” it
took place. By this miracle, Craton, and all his followers, were
converted to Christianity; and the two young men took back the
pearls, sold them, and then distributed the avails in charity.
Influenced by this example, two other young men of distinction,
Atticus and Eugenius, sold their estates, and distributed the avails
among the poor. For a time, they followed the apostle, and
possessed the power of working miracles. But, one day, being at
Pergamus, and seeing some well-dressed young men, glittering in
their costly array, they began to regret that they had sold all their
property, and deprived themselves of the means of making a figure
in the world. John read in their countenances and behavior the state
of their minds; and after drawing from them an avowal of their regret,
he bid them bring him each a bundle of straight rods, and a parcel of
smooth stones from the sea shore. They did so,――and the apostle,
after converting the rods into gold, and the stones into pearls, bid
them take them, and sell them, and redeem their alienated estates, if
they chose. At the same time, he plainly warned them, that the
consequence would be the eternal loss of their souls. While he
continued his long and pungent discourse, a funeral procession
came along. John now prayed, and raised the dead man to life. The
resuscitated person began to describe the invisible world, and so
graphically painted to Atticus and Eugenius the greatness of their
loss, that they were melted into contrition. The apostle ordered them
to do penance thirty days,――till the golden rods should become
wood, and the pearls become stones. They did so, and were
afterwards very distinguished saints.

Another story, of about equal merit, is told by the same authority.

While John continued his successful ministry at Ephesus, the
idolaters there, in a tumult, dragged him to the temple of Diana, and
insisted on his sacrificing to the idol. He warned all to come out of
the temple, and then, by prayer, caused it to fall to the ground, and
become a heap of ruins. Then, addressing the pagans on the spot,
he converted twelve thousand of them in one day. But Aristodemus,
the pagan high priest, could not be convinced, till John had drunken
poison without harm, by which two malefactors were killed instantly,
and also raised the malefactors to life. This resuscitation he
rendered the more convincing to Aristodemus, by making him the
instrument of it. The apostle pulled off his tunic, and gave it to
Aristodemus. “And what is this for?” said the high priest. “To cure you
of your infidelity,” was the reply. “But how is your tunic to cure me of
infidelity?” “Go,” said the apostle, “and spread it upon the dead
bodies, and say: ‘The apostle of our Lord Jesus Christ hath sent me
to resuscitate you, in his name, that all may know, that life and death
are the servants of Jesus Christ, my Lord.’” By this miracle the high
priest was fully convinced; and afterwards convinced the proconsul.
Both of them were baptized,――and persecution, from that time,
ceased. They also built the church dedicated to St. John, at
Ephesus.

For this series of fables I am indebted again to the kindness of Dr. Murdock, in whose
manuscript lectures they are so well translated from the original romances, as to make it
unnecessary for me to repeat the labor of making a new version from the Latin. The sight of
the results of abler efforts directly before me, offers a temptation to exonerate myself from a
tedious and unsatisfactory effort, which is too great to be resisted, while researches into
historical truth have a much more urgent claim for time and exertion.

The only one of all these fables that occurs in the writings of the Fathers, is the first,
which may be pronounced a tolerably respectable and ancient story. It is narrated by
Clemens Alexandrinus, (about A. D. 200.) The story is copied from Clemens Alexandrinus
by Eusebius, from whom we receive it, the original work of Clemens being now lost.
Chrysostom also gives an abridgement of the tale. (I. Paraenes ad Theodosius) Anastasius
Sinaita, Simeon Metaphrastes, Nicephorus Callistus, the Pseudo-Abdias, and the whole
herd of monkish liars, give the story almost verbatim from Clemens; for it is so full in his
account as to need no embellishment to make it a good story. Indeed its completeness in all
these interesting details, is one of the most suspicious circumstances about it; in short, it is
almost too good a story to be true. Those who wish to see all the evidence for and against
its authenticity, may find it thoroughly examined in Lampe’s Prolegomena to a Johannine
Theology (I. v. 4‒10.) It is, on the whole, the best authorized of all the stories about the
apostles, which are given by the Fathers, and may reasonably be considered to have been
true in the essential parts, though the minute details of the conversations, &c., are probably
embellishments worked in by Clemens Alexandrinus, or his informants.

The rest of these stories are, most unquestionably, all unmitigated falsehoods; nor does
any body pretend to find the slightest authority for a solitary particular of them. They are
found no where but in the novels of the Pseudo-Abdias, and the martyrologies. (Abdiae
Babyloniae episcopi et Apostolorum discipuli de Historia, lib. V., St. John.)

his death.

Respecting the close of his life, all antiquity is agreed that it was
not terminated by martyrdom, nor by any violent death whatever, but
by a calm and peaceful departure in the course of nature, at a very
great age. The precise number of years to which he attained can not
be known, because no writer who lived within five hundred years of
his time has pretended to specify his exact age. It is merely
mentioned on very respectable ancient authority, that he survived to
the beginning of the reign of Trajan. This noblest of the successors
of Julius, began his splendid reign in A. D. 98, according to the most
approved chronology; so that if John did not outlive even the first
year of Trajan, his death is brought very near the close of the first
century; and from what has been reasonably conjectured about his
age, compared with that of his Lord, it may be supposed that he
attained upwards of eighty years,――a supposition which agrees
well enough with the statement of some of the Fathers, that he died
worn out with old age.

Jerome has a great deal to say also, about the age of John at the time when he was
called, arguing that he must have been a mere boy at the time, because tradition asserts
that he lived till the reign of Trajan. Lampe very justly objects, however, that this proof
amounts to nothing, if we accept another common tradition, that he lived to the age of 100
years; which, if we count back a century from the reign of Trajan, would require him to have
attained mature age at the time of the call. Neither tradition however, is worth much. Our old
friend Baronius, too, comes in to enlighten the investigation of John’s age, by what he
considers indubitable evidence. He says that John was in his twenty-second year when he
was called, and passing three years with Christ, must have been twenty-five years old at the
time of the crucifixion; “because,” says the sagacious Baronius, “he was then initiated into
the priesthood.” An assertion which Lampe with indignant surprise stigmatizes as showing
“remarkable boldness,” (insignis audacia,) because it contains two very gross
errors,――first in pretending that John was ever made a priest, (sacerdos,) and secondly in
confounding the age required of the Levites with that of the priests when initiated. For
Baronius’s argument resting wholly on the very strange and unfounded notion, that John
was made a priest, is furthermore supported on the idea that the prescribed age for entering
the priesthood was twenty-five years; but in reality, the age thus required was thirty years,
so that if the other part of this idle story was true, this would be enough to overthrow the
conclusion. Lampe also alludes to the absurd idea of the painters, in representing John as a
young man, even while writing his gospel; while in reality all writers agree that that work was
written by him in his old age. This idea of his perpetual youth, once led into a blunder some
foolish Benedictine monks, who found in Constantinople an antique agate intaglio,
representing a young man with a cornucopia, and an eagle, and with a figure of victory
placing a crown on his head. This struck their monkish fancies at once, as an
unquestionable portrait of John, sent to their hands by a miraculous preservation.
Examination however, has shown it to be a representation of the apotheosis of Germanicus.

But even here, the monkish inventors have found room for new
fables; and though the great weight of all ancient testimony deprives
them of the opportunity to enter into the horrible details of a bloody
and agonizing death, they can not refuse themselves the pleasure of
some tedious absurdities, about the manner of his death and burial,
which are barely worth a partial sketch, to show how determined the
apostolic novelists are to follow their heroes to the very last, with the
glories of a fancifully miraculous departure.

The circumstances of his death are described in the

martyrologies, and by Abdias, in this manner. He had a vision
acquainting him with his approaching exit, five days before it
happened. On a Lord’s-day morning, he went to the great church at
Ephesus, bearing his name, and there performed public worship as
usual, at day-break. About the middle of the forenoon, he ordered a
deacon, and some grave diggers, with their tools, to accompany him
to the burying ground. He then set them to digging his grave, while
he, after ordering the multitude to depart, spent the time in prayer.
He once looked into the grave, and bid them dig it deeper. When it
was finished, he took off his outer garment, and spread it in the
grave. Then, standing over it, he made a speech to those present,
(which is not worth repeating,) then gave thanks to God for the
arrival of the time of his release,――and placing himself in the grave,
and wrapping himself up, he instantly expired. The grave was filled
up; and afterwards miracles took place at it, and a kind of manna
issued from it, which possessed great virtues.

There is no need, however, of such fables, to crown with the false

honors of a vain prodigy, the calmly glorious end of the “Last of the
Apostles.” It is enough for the Christian to know, that, with the long,
bright course of almost a century behind him, and with the mighty
works of his later years around him, John closed the solemn
apostolic drama, bearing with him in his late departure the last light
of inspiration, and the last personal “testimony of Jesus, which is the
spirit of prophecy.” Blessed in his works thus following him, he died
in the Lord, and now rests from his labors on the breast of that loved
friend, who cherished so tenderly the youthful Son of
Thunder;――on the bosom of his Redeemer and his Lord,――
“The bosom of his Father and his God.”
 PHILIP.
In all the three gospel lists, this apostle is placed fifth in order, the
variations in the arrangements of the preceding making no difference
in his position. In the first chapter of Acts, however, a different
arrangement is made of his name, as will be hereafter mentioned.
The mere mention of his name on the list, is all the notice taken of
him by either of the three first evangelists, and it is only in the gospel
of John, that the slightest additional circumstance can be learned
about him. From this authority it is ascertained that he was of
Bethsaida, the city of Andrew and Peter, and probably also the home
or frequent visiting-place of the sons of Zebedee, by the younger of
whom he is so particularly commemorated. Immediately after the
narration of the introduction of Andrew, John and Peter, to Jesus, in
the first chapter of this gospel, it is said that Jesus next proceeded
from Bethabara into Galilee, and there finds Philip; but the particular
place is not mentioned, though Bethsaida being immediately after
mentioned as his home, very probably was the place of the meeting.
Andrew and Peter, on their return home, had doubtless had no small
talk among their acquaintances, about the wonderful person
announced as the Messiah, to whom they had been introduced, and
had thus satisfied themselves that he was really the divine character
he was said to be. Philip too, must have heard of him in this way,
before he saw him; so that when Jesus met him, he was prepared at
once to receive the call which Jesus immediately gave
him,――“Follow me.” From the circumstance that he was the first
person who was summoned by Jesus, in this particular formula of
invitation to the discipleship, some writers have, not without reason,
claimed for Philip the name and honors of the Protoclete, or “first-
called;” though Andrew has commonly been considered as best
entitled to this dignity, from his being the first mentioned by name, as
actually becoming acquainted with Jesus. Philip was so devoutly
engaged, at once, in the cause of his new Master, that he, like
Andrew, immediately sought out others to share the blessings of the
discipleship; and soon after meeting one of his friends, Nathanael,
he expressed the ardor of his faith in his new teacher, by the words
in which he invited him to join in this honorable fellowship,――“We
have found him of whom Moses, in the law, and all the prophets did
write,――Jesus of Nazareth, the son of Joseph.” The result of this
application will be related in the life of the person most immediately
concerned. After this, no notice whatever is taken of Philip except
where incidental remarks made by him in the conversations of
Jesus, are recorded by John. Thus, at the feeding of the five
thousand, upon Jesus’s asking whether they had the means of
procuring food for the multitude, Philip answered, that “two hundred
pence would not buy enough for them, that every one might take a
little,”――thus showing himself not at all prepared by his previous
faith in Jesus, for the great miracle which was about to happen;
though Jesus had asked the question, as John says, with the actual
design of trying the extent of his confidence in him. He is afterwards
mentioned in the last conversations of Jesus, as saying to him,
“Show us the Father, and it sufficeth us,”――here too, betraying also
a most unfortunate deficiency, both of faith and knowledge, and
implying also a vain desire to gratify his eyes with still more
miraculous displays of the divine power of his Master; though, even
in this respect, he probably was no worse off than all the rest of the
disciples, before the resurrection of Jesus.

Protoclete.――Hammond claims this peculiar honor for Philip, with great zeal. (See
his notes on John i. 43.)

Of his apostleship not one word is recorded in the New Testament,

for he is no where mentioned in the Acts, except as being one of the
apostles assembled in the upper chamber after the ascension; nor
do the epistles contain the slightest allusion to him. Some of the
most ancient authorities among the Fathers, however, are distinct in
their mention of some circumstances of his later life; but all these
accounts are involved in total discredit, by the fact that they make
him identical with Philip the deacon, whose active and zealous
labors in Samaria, and along the coast of Palestine, from Gaza,
through Ashdod to Caesarea, his home, are minutely related in the
Acts, and have been already alluded to, in that part of the life of
Peter which is connected with these incidents. It has always been
supposed, with much reason, in modern times, that the offices of an
apostle and a deacon were so totally distinct and different, that they
could never both be borne by one and the same person; but the
Fathers, even the very ancient ones, seem to have had not the
slightest idea of any such incompatibility; and therefore uniformly
speak of Philip the apostle, as the same person with Philip, one of
the seven deacons, who is mentioned by Luke, in the Acts of the
Apostles, as having lived at Caesarea, in Palestine, with his
daughters, who were virgins and prophetesses. Testimony more
distinct than this, can no where be found, among all the Fathers, on
any point whatever; and very little that is more ancient. Yet how does
it accord with the notions of those who revere these very Fathers as
almost immaculate in truth, and in all intellectual, as well as moral
excellence? What is the evidence of these boasted Fathers worth,
on any point in controversy about apostolic church government, or
doctrine, or criticism, if the modern notion of the incompatibility of the
two offices of apostle and deacon is correct?

The testimony of the Fathers on this point, is simply this. Eusebius (Church History, III.
31,) quotes Polycrates, bishop of Ephesus, who, in his letter to Victor, bishop of Rome,
(written A. D. 195, or 196,) makes mention of Philip in these exact words: “Philip, who was
one of the twelve apostles, died in Hierapolis;” (in Phrygia;) “and so did two of his
daughters, who had grown old in virginity. And another of his daughters, after having
passed her life under the influence of the Holy Spirit, was buried at Ephesus.” This certainly
is a most perfect identification of Philip the apostle with Philip the deacon; for it is this latter
person who is particularly mentioned in Acts, xxi. 8, 9, as “having four daughters who did
prophesy.” He is there especially designated as “Philip the evangelist, one of the seven,”
while Polycrates expressly declares, that this same person “was one of the twelve.”
Eusebius also, in the preceding chapter, quotes Clemens Alexandrinus as mentioning Philip
among those apostles who were married, because he is mentioned as having had
daughters; and Clemens even adds that these were afterwards married, which directly
contradicts the previous statement of Polycrates, that three of them died virgins, in old age.
Yet Eusebius quotes all this stuff, with approbation.
 Papias, (A. D. 140,) bishop of Hierapolis, the very place of the death and burial of Philip,
is represented by Eusebius as having been well acquainted with the daughters of Philip,
mentioned in Acts, as the virgin prophetesses. Papias says that he himself “heard these
ladies say that their father once raised a dead person to life, in their time.” But it deserves
notice, that Papias, the very best authority on this subject, is no where quoted as calling this
Philip “an apostle;” though Eusebius, on his own authority, gives this name to the Philip of
whom Papias speaks. It is therefore reasonable to conclude, that this blunder, betraying
such a want of familiarity with the New Testament history, originated after the time of
Papias, whose intimate acquaintance with Philip’s family would have enabled him to say, at
once, that this was the deacon, and not the apostle; though it is not probable that he was
any less deplorably ignorant of the scriptures than most of the Fathers were.

Now what can be said of the testimony of the Fathers on points where they can not refer,
either to their own personal observation, or to informants who have seen and heard what
they testify? The only way in which they can be shielded from the reproach of a gross
blunder and a disgraceful ignorance of the New Testament, is, that they were right in
identifying these two Philips, and that modern theologians are wrong in making the
distinction. On this dilemma I will not pretend to decide; for though so little reverence for the
judgment and information of the Fathers has been shown in this book, there does seem to
me to be some reason for hesitation on this point, where the Fathers ought to have been as
well informed as any body. They must have known surely, whether, according to the notions
of those primitive ages of Christianity, there was any incompatibility between the apostleship
and the deaconship! If their testimony is worth anything on such points, it ought to weigh so
much on this, as to cause a doubt whether they are not right, and the moderns wrong.
However, barely suggesting this query, without attempting a decision, as Luther says, “I will
afford to other and higher spirits, occasion to reflect.”

This is all the satisfaction that the brief records of the inspired or
uninspired historians of Christianity can give the inquirer, on the life
of this apostle;――so unequal were the labors of the first ministers of
Christ, and their claims for notice. Philip, no doubt, served the
purpose for which he was called, faithfully; but in these brief
sketches, there are no traces of any genius of a high character, that
could distinguish him above the thousands that are forgotten, but
whose labors, like those of the minutest animals in a mole-hill,
contribute an indispensable portion to the completion of the mass, in
whose mighty structure all their individual efforts are swallowed up
forever.

And though the ancient Polycrates may have blundered

grievously, in respect to the apostle’s personal identity, his hope of
the glorious resurrection of those whom he supposed to have died in
Asia will doubtless be equally well rewarded, if, to the amazement of
the Fathers, the apostle Philip should rise at last from the dust of
Babylon, or the ashes of Jerusalem, while his namesake, the
evangelist, shall burst from his tomb in Hierapolis. “For,” as
Polycrates truly says, “in Asia, some great lights have gone down,
which shall rise again on that day of the Lord’s approach, when he
shall come from the heavens in glory, and shall raise up all his
saints;――Philip, one of the twelve apostles, who sleeps at
Hierapolis, with his venerable virgin daughters,――John, who lay in
the bosom of the Lord, and who is laid at Ephesus,――Polycarp, at
Smyrna,――Thraseas, at Eumenia,――Sagaris, at
Laodicea,――Papirius and Melito, at Sardis――all await the
visitation of the Lord from the heavens, in which he shall raise them
from the dead.”

NATHANAEL, BAR-THOLOMEW.
his name and call.

In respect to this apostle, there occurs a primary question about

his name, which is given so differently in different sacred authorities,
as to induce a strong suspicion that the two names refer to two
totally distinct persons. The reasons for applying the two words,
Nathanael and Bartholomew, to the same person, are the
circumstances,――that none of the three first evangelists mention
any person named Nathanael, and that John never mentions the
name Bartholomew,――that Bartholomew and Nathanael are each
mentioned on these different authorities, among the chosen disciples
of Jesus,――that Bartholomew is mentioned by the three first
evangelists, on all the lists, directly after Philip, who is by John
represented as his intimate friend,――and that Bartholomew is not
an individual name, but a word showing parentage merely,――the
first syllable being often prefixed to Syriac names, for this purpose;
and Bar-Tholomew means the “son of Tholomew,” or “Tholomai;” just
as Bar-Jonah means the “son of Jonah;” nor was the former any
more in reality the personal, individual name of Nathanael, than the
latter was of Peter; but some circumstance may have occurred to
make it, in this instance, often take the place of the true individual
name.

A few very brief notices are given of this apostle by John, who
alone alludes to him, otherwise than by a bare mention on the list. It
is mentioned in his gospel that Nathanael was of Cana, in Galilee, a
town which stood about half-way between lake Gennesaret and the
Mediterranean sea; but the circumstances of his call seem to show
that he was then with Philip, probably at or near Bethsaida. Philip,
after being summoned by Jesus to the discipleship, immediately
sought to bring his friend Nathanael into an enjoyment of the honors
of a personal intercourse with Jesus, and invited him to become a
follower of the Messiah, foretold by Moses and the prophets, who
had now appeared, as Jesus of Nazareth, the son of Joseph. On
hearing of that mean place, as the home of the promised King of
Israel, Nathanael, with great scorn, replied, in inquiry, “Can any good
thing come out of Nazareth?” To this sneering question, Philip
answered by the simple proposition, “Come and see;”――wisely
judging that no argument could answer his friend’s prejudice so well
as an actual observation of the character and aspect of the
Nazarene himself. Nathanael, accordingly, persuaded by the
earnestness of his friend, came along with him, perhaps, partly to
gratify him, but, no doubt, with his curiosity somewhat moved to
know what could have thus brought Philip into this devout regard for
a citizen of that dirty little town; and he therefore readily
accompanied him to see what sort of prophet could come out of
Nazareth.

The words with which Jesus greeted Nathanael, even before he

had been personally introduced, or was prepared for any salutation,
are the most exalted testimonial of his character that could be
conceived, and show at once his very eminent qualifications for the
high honors of the apostleship. When Jesus saw Nathanael coming
to him, he said, “Behold a true son of Israel, in whom is no
guile!”――manifesting at once a confidential and intimate knowledge
of his whole character, in thus pronouncing with such ready decision,
this high and uncommon tribute of praise upon him, as soon as he
appeared before him. Nathanael, quite surprised at this remarkable
compliment from one whom he had never seen until that moment,
and whom he supposed to be equally ignorant of him, replied with
the inquiry, “Whence knowest thou me?” Jesus answered, “Before
Philip called thee, when thou wast under the fig-tree, I saw thee.”
The fig-trees of Palestine, presenting a wide, leafy cover, and a
delightful shade, were often used in the warm season as places of
retirement, either in company, for conversation, or in solitude, for
meditation and prayer, as is shown in numerous passages of the
Rabbinical writings; and it was, doubtless, in one of these
occupations that Nathanael was engaged, removed, as he
supposed, from all observation, at the time to which Jesus referred.
But the eye that could pierce the stormy shades of night on the
boisterous waves of Galilee, and that could search the hearts of all
men, could also penetrate the thick, leafy veil of the fig-tree, and
observe the most secret actions of this guileless Israelite, when he
supposed the whole world to be shut out, and gave himself to the
undisguised enjoyment of his thoughts, feelings, and actions, without
restraint. Nathanael, struck with sudden but absolute conviction, at
this amazing display of knowledge, gave up all his proud scruples
against the despised Nazarene, and adoringly exclaimed, “Rabbi!
thou art the Son of God,――thou art the King of Israel.” Jesus,
recognizing with pleasure the ready faith of this pure-minded
disciple, replied, “Because I said unto thee, ‘I saw thee under the fig-
tree,’――believest thou? Thou shalt see yet greater things than
these.” Then turning to Philip as well as to Nathanael, he says to
them both, “I solemnly assure you, hereafter ye shall see heaven
open, and the angels of God ascending and descending upon the
Son of Man.”

On the day but one after this occurrence, as John records, Jesus
was in Cana of Galilee, the residence of Nathanael, and was present
at a wedding which took place there. From the circumstance that the
mother of Jesus was there also, it would seem likely that it was the
marriage of some of their family friends; otherwise the conjecture
might seem allowable, that the presence of Jesus and his disciples
on this occasion, was in some way connected with the introduction of
Nathanael to Jesus; and that this new disciple may have been some
way concerned in this interesting event. The manner in which the
occurrence is announced,――it being next specified, that two days
after the occurrences recorded in the end of the first chapter, Jesus
was present at a marriage in Cana of Galilee,――would seem to
imply very fairly, that Jesus had been in some other place
immediately before; and it is probable therefore, that he
accompanied Nathanael home from Bethsaida, or whatever place
was the scene of his calling to the discipleship, along with Philip. The
terms of the statement are not, however, absolutely incompatible
with the idea of this first introduction of these two disciples to Jesus,
in Cana itself, which may have been the part of Galilee into which
Jesus is said to have gone forth, after leaving Bethabara; although,
the reasons above given make it probable that Bethsaida was the
scene. After this first incident, no mention whatever is made of
Nathanael, either under his proper name, or his paternal appellation,
except that when the twelve were sent forth in pairs, he was sent
with his friend Philip, that those who had been summoned to the
work together, might now go forth laboring together in this high
commission. One solitary incident is also commemorated by John, in
which this apostle was concerned, namely, the meeting on the lake
of Gennesaret, after the resurrection, where his name is mentioned
among those who went out on the fishing excursion with Peter. His
friend Philip is not there mentioned, but may have been one of the
“two disciples,” who are included without their names being given.
From this trifling circumstance, some have concluded that Nathanael
was a fisherman by trade, as well as the other four who are
mentioned with him; and certainly the conjecture is reasonable, and
not improbable, except from the circumstance, that his residence
was at Cana, which is commonly understood to have been an inland
town, and too far from the water, for any of its inhabitants to follow