Taxation I (C237)

Correct answer C. They receive a 30-day letter to dispute the adjustments.

Explanation:

If a taxpayer disagrees with the proposed adjustments after an audit, the IRS issues a "30-day letter," which provides the taxpayer with 30 days to either agree with the changes or appeal the decision through the IRS Office of Appeals. This allows the taxpayer to formally challenge the adjustments before they become final.

Why other options are wrong:

A. They must pay the tax owed immediately without any dispute.

Taxpayers have the right to dispute IRS audit findings before making payment. The appeals process allows them to present their case before being required to pay additional taxes.

B. They can ignore the proposed adjustments without any consequences.

Ignoring the adjustments does not make them go away. If the taxpayer does not respond within the given timeframe, the IRS will proceed with the adjustments and issue a Notice of Deficiency, leading to further tax liabilities and potential penalties.

D. They automatically receive a refund without further action.

A refund is only issued if the IRS determines that the taxpayer overpaid taxes. If the taxpayer disputes adjustments, they must actively appeal or provide additional documentation to support their claims.

Correct answer D. How the tax burden should be distributed fairly among taxpayers

Explanation:

The principle of equity in taxation refers to the fair distribution of the tax burden among individuals. It is based on two key concepts:

Horizontal equity: Taxpayers with similar income and circumstances should pay similar amounts in taxes.

Vertical equity: Taxpayers with higher income or wealth should pay higher taxes to reflect their greater ability to contribute.

Why other options are wrong:

A. The total amount of tax revenue generated by the system.

This is incorrect because equity focuses on fairness in tax distribution, not the total revenue collected.

B. The ease of understanding tax obligations by taxpayers.

This is incorrect because the ease of understanding taxes is related to tax simplicity, not tax equity.

C. The efficiency of tax collection methods used by the government.

This is incorrect because efficiency relates to how well the tax system operates with minimal costs, not how fairly the tax burden is distributed.

Correct answer C. 16th Amendment

Explanation:

The 16th Amendment to the U.S. Constitution, ratified in 1913, granted Congress the power to impose a federal income tax without apportioning it among the states or basing it on the U.S. Census. This amendment overturned prior legal obstacles and allowed for the modern income tax system used today.

Why other options are wrong:

A. 18th Amendment

The 18th Amendment prohibited the manufacture, sale, and transportation of alcohol in the United States. It had no relation to taxation and was later repealed by the 21st Amendment.

B. 10th Amendment

The 10th Amendment reserves powers not explicitly granted to the federal government to the states or the people. It does not grant Congress any taxing authority.

D. 14th Amendment

The 14th Amendment addresses citizenship rights and equal protection under the law. While it has broad legal implications, it does not grant Congress the power to tax income.

Correct answer B. Specific tax

Explanation:

A specific tax is a fixed amount imposed on each unit of a good or service regardless of its price. This contrasts with ad valorem taxes, which are based on a percentage of value. An example of a specific tax is a per-gallon tax on gasoline or a per-pack tax on cigarettes.

Why other options are wrong:

A. Proportional tax

A proportional tax applies the same percentage to all taxpayers, regardless of their income or the unit of the taxed item. It is not based on a per-unit or per-head basis.

C. Ad valorem tax

An ad valorem tax is based on the value of the good rather than a fixed per-unit charge. For example, sales tax is calculated as a percentage of the item's price, not a fixed amount per unit.

D. Progressive tax

A progressive tax increases as income or value increases (e.g., income tax brackets). It is not a per-unit or per-head tax.

Correct answer A. Can be taxed as sole proprietorship or corporation.

Explanation:

A Limited Liability Company (LLC) is a flexible business entity that can choose how it is taxed. By default, a single-member LLC is taxed as a sole proprietorship, and a multi-member LLC is taxed as a partnership. However, an LLC can elect to be taxed as an S-corporation or C-corporation for tax purposes. This flexibility is one of the key benefits of forming an LLC.

Why other options are wrong:

B. Is a flow-through entity only.

While LLCs are typically treated as flow-through entities (where profits and losses pass through to the owners’ tax returns), they can elect to be taxed as a corporation, which is not a flow-through entity.

C. Cannot have more than one owner.

LLCs can have multiple owners (members). A single-member LLC is taxed as a sole proprietorship, while a multi-member LLC is usually taxed as a partnership unless an election is made.

D. Always taxed as a corporation.

LLCs are not automatically taxed as corporations. They can choose their tax classification based on the preferences of the owners.

Correct answer C. US Constitution

Explanation:

The U.S. Constitution is the highest authority in U.S. tax law because it grants Congress the power to levy taxes through the 16th Amendment. All tax laws, including the Internal Revenue Code (IRC) and Treasury Regulations, must conform to constitutional principles.

Why other options are wrong:

A. Treasury Regulations.

Treasury Regulations are important but do not override the Internal Revenue Code or the U.S. Constitution. They provide official interpretations of tax laws but are subordinate to statutory law.

B. Internal Revenue Code.

The IRC is the primary body of tax law enacted by Congress, but it derives its authority from the U.S. Constitution.

D. Court decisions.

Court decisions interpret tax laws but do not create tax laws. They help clarify ambiguities, but courts cannot override the Constitution or Internal Revenue Code unless a law is ruled unconstitutional.

Correct answer B. Collected in accordance with a contract between the state and taxpayer.

Explanation:

Taxes are not based on a contractual agreement between the taxpayer and the state. Instead, they are mandatory contributions imposed by law for the purpose of funding government services. Unlike a contract, where both parties agree to terms voluntarily, taxes are enforced obligations that citizens and businesses must comply with by virtue of legal authority.

Why other options are wrong:

A. Enforced contributions

This is correct because taxes are compulsory payments mandated by law. A taxpayer cannot opt out of paying taxes unless they fall under an exemption provided by tax laws.

C. Proportional in character and personal to the taxpayer

This is correct because many tax systems follow a proportional or progressive structure, where taxes are assessed based on income, transactions, or value of property. Additionally, tax obligations are personal to the taxpayer, meaning each individual or entity is responsible for their own tax liabilities.

D. Levied for support of the government and for all its public needs

This is correct because the primary purpose of taxation is to generate revenue for the government, which is used for public infrastructure, defense, education, health services, and other societal needs.

Correct answer B. Itemized deductions

Explanation:

Itemized deductions are specific expenses that taxpayers can claim on their tax returns to reduce taxable income, provided they maintain proper documentation. These deductions include medical expenses, mortgage interest, charitable contributions, and state and local taxes. Taxpayers must keep records and receipts to substantiate their claims, and they can choose to itemize if their total deductions exceed the standard deduction.

Why other options are wrong:

A. Standard deductions

Standard deductions are a fixed dollar amount that taxpayers can subtract from their taxable income without needing to keep records of specific expenses. The IRS sets this amount annually, and it varies based on filing status. Unlike itemized deductions, standard deductions do not require documentation of personal expenditures.

C. Dependency exemptions

Dependency exemptions were deductions for taxpayers who supported qualifying dependents, such as children or elderly parents. However, these exemptions were eliminated under the Tax Cuts and Jobs Act (TCJA) of 2017. Since they no longer apply, they are not relevant to personal expenditures that require record-keeping.

D. Personal exemptions

Personal exemptions were deductions that reduce taxable income for the taxpayer and their dependents, but they were also eliminated by the TCJA of 2017. Since personal exemptions no longer exist in the federal tax system, they are not applicable to the question.

Correct answer C. Head of household

Explanation:

Head of household status generally results in lower tax liability than single or married filing separately. To qualify, the taxpayer must be unmarried at the end of the year and maintain a household for a qualifying dependent, such as their child. Since the taxpayer gave birth and divorced in the same year, they can file as head of household if they meet the support and residency requirements. This status provides a higher standard deduction and more favorable tax brackets than single filing status.

Why other options are wrong:

A. Married filing jointly

Although married filing jointly typically provides the lowest tax rates for married couples, this taxpayer was divorced by the end of the year. Since they were not married on the last day of the year, they cannot use this status.

B. Single

Filing as single results in a higher tax liability than head of household because the standard deduction is lower and the tax brackets are less favorable. Since the taxpayer has a qualifying dependent (their child), they qualify for the more beneficial head of household status.

D. Married filing separately

This status often results in a higher tax burden than head of household or married filing jointly due to unfavorable tax brackets and loss of certain tax credits. Additionally, since the taxpayer was divorced by the end of the year, they do not qualify for married filing separately.