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311-Chapter 2 Homework Solutions

311-Chapter 2 Homework Solutions - Assignment#1 2 The...

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Assignment #1 2. The chapter stated that the ability-to-pay concept is fundamental to the operation of the income tax system. What is the ability-to-pay concept, and what two basic aspects of the income tax system are derived from the concept? What might the tax system be like without this concept? The ability-to-pay concept states that the tax paid should be related to the amount that the taxpayer has to pay the tax. This concept is implemented by using taxable income (income net of deductions) as the tax base for figuring the tax. This gives recognition to differing levels of income as well as differing levels of deductions by each taxpayer. The second aspect is the use of progressive tax rates in the calculation of the tax. This rate structure imposes lower tax rates on lower income levels while taxing higher levels of income at higher rates. Without this concept, the income tax could be very different. First, a different tax base could be used, such as a tax on all income received. In addition, the tax rate structure might not be progressive. For example, a tax on all income received might be subject to a single tax rate (proportional tax structure). 3. What is an arm's-length transaction? What is its significance to income taxation? An arm's-length transaction is one in which the parties to the transaction bargain in good faith for their individual benefit, not for the mutual benefit of the group. That is, the price of the transaction is a fair market value. The importance for income taxation is that transactions not made at arm's- length are usually not given their intended tax effect. This has led to the related party rules which define situations in which entities do not bargain at arm's-length. Special rules for transactions between related parties have been developed to discourage such transactions. 8. What are the two basic methods of accounting that may be used by taxpayers? How do the two basic methods differ? The two basic accounting methods that are acceptable for tax purposes are the cash method and the accrual method. The basic difference between the two methods is the criteria used to determine the timing of the recognition of income and expenses. The cash method recognizes income when cash or its equivalent is received. Expenses are deducted when they are paid. That is, it is basically a cash flow system (although capital expenditures cannot be deducted in total in the period in which they are paid). The accrual method recognizes income when it is earned (the receipt of cash or its equivalent is not a factor). Expenses are deducted when all events have occurred that fix the liability for the payment and the amount of the payment can be reasonably estimated. The payment of the expense is not a factor for accrual basis taxpayers.
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10. Chapter 1 discussed how gross income is equal to all income received, less exclusions. Which concepts form the basis for this calculation of gross income? Explain.
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311-Chapter 2 Homework Solutions - Assignment#1 2 The...

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