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Chap004_rev_110411 - Chapter 04 Individual Income Tax...

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Chapter 04 - Individual Income Tax Overview Chapter 4 Individual Income Tax Overview SOLUTIONS MANUAL Discussion Questions 1. [LO 1] How are realized income, gross income, and taxable income similar, and how are they different? Realized income is more broadly defined than gross income which is more broadly defined than taxable income. Gross income includes all realized income that taxpayers are not allowed to exclude from gross income or are not permitted to defer including in gross income to a later year. Consequently, gross income is the income that taxpayers actually report on their tax returns and pay taxes on. In the tax formula, taxable income is gross income minus allowable deductions for and from AGI. Taxable income is the base used to compute the tax due before applicable credits. However, any income included in gross income can be considered “taxable” income because gross income is income that is taxable causes an increase in the taxes that taxpayer is required to pay (gross income increases taxable income). 2. [LO 1] Are taxpayers required to include all realized income in gross income? Explain. No. Taxpayers are allowed to permanently exclude certain types of income from gross income or defer certain types of income from taxation (gross income) until a subsequent tax year. Consequently, taxpayers are not required to include all realized income in gross income. 3. [LO 1] All else equal, should taxpayers prefer to exclude income or defer it? Why? Taxpayers should prefer to exclude income rather than defer income. When they exclude income they are never taxed on the income. When they defer income, they are still taxed on the income, but they are taxed in a subsequent tax year. 4. [LO 1] Why should a taxpayer be interested in the character of income received? A taxpayer should be interested in the character of income received because the character of the income determines the rate at which the income will be taxed. Tax exempt and tax deferred income is not taxed in the current year. Ordinary income is taxed at the rates provided in the tax rate schedule. Qualified dividend income and long-term capital gains are generally taxed at a maximum 15% rate. 5. [LO 1] Is it easier to describe what a capital asset is or what it is not? Explain. It is easier to describe what a capital asset is not. In general, a capital asset is any asset other than Accounts receivable from the sale of goods or services. Inventory and other assets held for sale in the ordinary course of business. Assets used in a trade or business, including supplies. Thus any asset used for investment or personal purposes is considered to be a capital asset. 4-1
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Chapter 04 - Individual Income Tax Overview 6. [LO 1] Are all capital gains (gains on the sale or disposition of capital assets) taxed at the same rate? Explain.
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