Taxchapter12.docx

Taxchapter12.docx

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Taxchapter12

Chapter12

Compensation

SOLUTIONSMANUAL

DiscussionQuestions:

1.[LO1]Shaneisanemployeewhohashadarelativelyconsistentincomeovertheyears.Hiswithholdingisprettymuchrightontargetwithhisactualtaxliability,soherarelyhasmuchofataxrefundortaxduewithhistaxreturn.Atthebeginningofthisyear,Shanesoldsomepropertyatalargegain.WhatissuesrelatingtowithholdingshouldShaneconsider?

Whatwouldyouadvisehimtodo?

TheprimaryissueforShaneisdecidinghowtopaythetaxesthathewilloweduetothegainontheproperty.Itappearsthathiscurrentwithholdingwillnotbeenoughtocoverthetaxliability.Shanehasseveraloptionswithrespecttowithholding.

First,hecouldimmediatelycompleteanewFormW4todecreasethenumberofwithholdingallowancesinordertoincreasetheamountoftaxeswithheldfromeachpaychecksothatbytheendoftheyearhewillhaveenoughtaxwithheld.Insteadofdecreasingallowances,hecouldsimplyspecifyanadditionalamounttobewithheldfromeachpaychecksothatthetaxliabilityiscoveredbytheendoftheyear.

Second,becausetaxwithholdingisgenerallytreatedasthoughitismadeevenlythroughouttheyear,hecouldwaituntilhislastfewpaychecksandhaveenoughextrataxwithheldtocovertheliability.ThisapproachhastheadvantageofprovidingShanewithaninterestfreeloanfromthegovernmentuntilhepaysthetaxes.But,itmaymeanthatShanewon’thavemuchcashflowforthelastfewpaychecksoftheyear.

Finally,hecouldmakeanestimatedtaxpaymentorhecouldwaitandpaythetaxwiththereturn,buthemayenduppayinginterestandpenaltiesifhewaitstopaytaxwiththereturn.

2.[LO1]JuanitarecentlystartedemploymentforMapleCorporation.Fortaxpurposes,Juanitafilesasahead-of-householdfilingstatuswiththreedependents.Juanitaneedstodeterminethenumberof“withholdingexemptions”toclaimonherW-4form.Shouldsheclaimfourwithholdingexemptionsorshouldsheclaimmore?

Whatfactorsshouldsheconsiderinmakingthisdetermination?

Whenshefileshertaxreturn,Juanitawillbeabletoclaimonepersonalexemptionandthreedependencyexemptions.Theseexemptionswillreducehertaxableincomeandcorrespondinglyreducehertaxliability.So,whenJuanitacompletesherW-4form,shouldsheclaimfourwithholdingexemptions?

Ingeneral,thewithholdingtablesaredesignedsothattaxpayerswillhavewithholdingtaxesfairlyclosetotheamountoftheiractualtaxliabilitywhentheyclaimthesamenumberofwithholdingallowancesasthenumberofpersonalanddependencyexemptionstheyareclaimingontheirtaxreturn.

However,thisisonlyageneralrule.Incertaincircumstances,thetaxpayermayneedtoadjustherwithholdingexemptionsinordertohavetheproperamountoftaxeswithheld.Forexample,thewithholdingtablesanticipatethatthetaxpayerwillusethestandarddeductionandwillnotitemizedeductions.So,ifthetaxpayerisitemizingdeductions,thetaxpayermayneedtoclaimmorewithholdingexemptionsthanpersonalanddependencyexemptionstoensurethatshedoesn’thavemoretaxesthannecessarywithheld.

Alsothetablesassumethatthetaxpayer’ssalaryisheronlysourceofincome.Consequently,taxpayerswithanincomeearning（employedorself-employed）spousemayneedtoadjustherexemptionstoaccountforthis.Further,becausetaxpayerswithhighincomesmaybesubjecttothealternativeminimumtaxormayhavecertaintaxbenefitsphased-out,taxpayerswithhighincomesmayneedtoreportadifferentnumberofwithholdingexemptionsthanpersonalexemptions.

Finally,becausethetablesdon’tanticipatethatthetaxpayerwillhavedeductiblelosses,taxpayerswithdeductiblelosses（e.g.,capitallosses,flowthroughlossesfromownedentities,andrentallosses）,mayneedtoincreasetheirwithholdingexemptionsabovethenumberofpersonalanddependencyexemptions.Juanitamayhavetheseandotherreasonswhysheshouldclaimmoreorlesswithholdingexemptionsthanthenumberofpersonalanddependencyexemptionsshewillbeclaimingonhertaxreturn.Shewillneedtoprojectherincomeandtaxliabilityfortheyearinordertodeterminetheappropriateamountofwithholdingtaxtobewithheldandthecorrespondingnumberofwithholdingexemptionstoclaim.

3.[LO1]Aretaxpayers’entirewagessubjecttotheFICAtax?

Explain.

EmployeesmustpayFICAtaxesontheirwages.ThistaxconsistsofbothaSocialSecurityandaMedicarecomponent.TheSocialSecuritytaxisintendedtoprovidebasicpensioncoveragefortheretiredanddisabled.TheMedicaretaxhelpspaymedicalcostsforqualifyingindividuals.EmployeespaySocialSecuritytaxatarateof6.2percentonthewagebaseandMedicaretaxatarateof1.45percentontheirwages.ThewagebaseonwhichSocialSecuritytaxesarepaidislimitedtoanannuallydeterminedamount.The2010limitis$106,800whichisthesameasthe2009limit.BecausethereisnowagebasefortheMedicarecomponentoftheFICAtax,ataxpayer’sentirewageswillbesubjecttothisportionoftheFICAtax.

4.[LO1]NicoleandBraxtonareeach50percentshareholdersofNBCorporation.Nicoleisalsoanemployeeofthecorporation.NBisacalendar-yeartax-payerandusestheaccrualmethodofaccounting.Thecorporationpaysitsemployeesmonthlyonthefirstdayofthemonthafterthesalaryisearnedbytheemployees.WhatissuesmustNBconsiderwithrespecttothedeductibilityofthewagesitpaystoNicoleifNicoleisBraxton’ssister?

WhatissuesariseifNicoleandBraxtonareunrelated?

IfNicoleandBraxtonaresisterandbrother,accordingto§267（b）oftheInternalRevenueCodeNicoleandNBCorporationareconsideredtobe“relatedparties.”Nicoleistreatedasowningher50percentandherbrother’s50percentforatotalof100

percentownership.BecauseNBandNicolearerelated,NBisnotallowedtodeductthesalaryexpenseitaccruedforbookpurposesonthesalaryitowestoNicoleuntiltheyearinwhichNicolerecognizesincome.Thisdoesnotcauseanyissuesuntilthelastpaycheckoftheyear.Forbookpurposes,NBaccruesanddeductsNicole’sDecembersalarybutfortaxpurposes,NBisnotabletodeductthesalaryuntilJanuary1whenNicolereceiveshercheck.

IfNicoleandBraxtonareunrelated,Nicolewouldown50percentofNB,andshewouldnotbeconsideredarelatedpartytoNBbecauseshedoesnotownmorethan50percentofNB.NBisallowedtodeductthecompensationearnedbyNicoleinDecemberoftheprioryearaslongasitpaysthecompensationwithin2½monthsofyearend（byMarch15）.Inthiscase,NBpaysthecompensationatthebeginningofJanuary,soitwouldbeallowedtodeductthecompensationexpenseitaccruedinDecemberforNicole.

5.[LO1]Holdingallelseequal,doesanemployerwithahighermarginaltaxrateorlowermarginaltaxratehavealowerafter-taxcostofpayingaparticularemployee’ssalary?

Explain.

Holdingallelseequal（includingtheamountoftheemployee’ssalary）anemployerwithahighermarginaltaxratewillhavealowerafter-taxcostofpayinganemployee’ssalary.Thereasonisthattheemployer’safter-taxcostofthesalaryisthebeforetaxcostminusthetaxsavingsfromdeductingtheemployee’ssalary.Thetaxsavingsfromadeductionaregreaterthehigherthemarginaltaxrate.Becausethehighmarginaltaxrateemployerhasgreatertaxsavingsfromdeductingtheemployee’ssalary,thehighmarginaltaxrateemployerhasalowerafter-taxcostofpayingtheemployee’ssalary.

6.[LO1]Whatarenontaxreasonswhyacorporationmaychoosetocapitsexecutives’salariesat$1million?

Acorporationmaychoosetocapitsexecutives’salariesat$1million,evenifitisnotconcernedaboutthelossofthetaxdeduction,tosendasignaltoshareholders.Notexceedingthelimitsignalstotheshareholdersthatthecorporationisbeingfiscallyresponsibleby

（1）notoverpayingexecutives,and

（2）ensuringthatallcompensationpaidtoexecutivesistaxdeductible.Again,thefocushereisthesignalthispolicysendstotheshareholdersandnottheactualtaxbenefitsderivedbycappingsalariesat$1million.

7.[LO1]Whataretaxreasonswhyacorporationmaychoosetocapitsexecutives’salariesat$1million?

Corporationsmaycaptheirexecutives’salariesat$1milliontoensurethatthecompanyisabletodeductthecompensationexpenseforthefullamountofthe（non-performancebased）salary.Thisisimportantbecausethegovernmenteffectivelysubsidizesthe（non-performancebased）salaryupto$1milliondollars.Thismeansforacorporationina35percentmarginaltaxbracket,thegovernmentwouldeffectivelybepaying$350,000ofthefirst$1millioninsalary.

However,forsalaryabove$1million,iftheexecutiveistheCEOoroneoftheotherfourhighestcompensatedofficers,thegovernmentdoesnotallowataxdeduction.Consequently,thegovernmentdoesnotsubsidizethisexcesssalarywhichmakesthesalaryabove$1millionmoreexpensivetoprovide,onanafter-taxbasis,thansalaryupto$1million.

8.[LO1]LeaisahighlypaidexecutivewithMCC,Inc.,apubliclytradedcorporation.WhatarethecircumstancesunderwhichMCCwillbeabletodeductmorethan$1millionofcompensationpaidtoLeaduringtheyear?

Thisquestiondealswiththe§162（m）limitationonsalarydeductibilityanditsexceptions.First,the§162（m）limitationappliestotheCEOandthefourothermosthighlycompensatedofficers.IfLeadoesnotfitthisdescription,MCCwouldbeabletodeductthefullsalarypaidtoLeaevenifitexceeds$1million.Second,§162（m）providesexceptionstothegeneralrulelimitingthedeductibilityofco