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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
Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2018 by McGraw-Hill Education. All rights
­reserved. Printed in the United States of America. Previous editions © 2017, 2016, and 2015. No part of this publication may be
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Some ancillaries, including electronic and print components, may not be available to customers outside the United States.
This book is printed on acid-free paper.
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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
 ®

Required=Results
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McGraw-Hill Connect®
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that is proven to deliver better results for
students and instructors.
Connect empowers students by continually
adapting to deliver precisely what they
need, when they need it, and how they need
it, so your class time is more engaging and
effective.

73% of instructors who use

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.

Analytics
Connect Insight®
Connect Insight is Connect’s new one-
of-a-kind visual analytics dashboard that
provides at-a-glance information regarding
student performance, which is immediately
actionable. By presenting assignment,
assessment, and topical performance results
together with a time metric that is easily
visible for aggregate or individual results,
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
THE ADAPTIVE
READING EXPERIENCE
DESIGNED TO TRANSFORM
THE WAY STUDENTS READ

More students earn A’s and

B’s when they use McGraw-Hill
Education Adaptive products.

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,
and driving the student toward comprehension
and retention of the subject matter. Available on
tablets, SmartBook puts learning at the student’s
fingertips—anywhere, anytime.

Over 8 billion questions have been

answered, making McGraw-Hill
Education products more intelligent,
reliable, and precise.

www.mheducation.com
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

At McGraw-Hill, we understand that getting the most from new technology can be challenging. That’s
why our services don’t stop after you purchase our products. You can contact our Product Specialists 24
hours a day to get product training online. Or you can search the knowledge bank of Frequently Asked
Questions on our support website. For Customer Support, call 800-331-5094, or visit www.mhhe.com/
support. One of our Technical Support Analysts will be able to assist you in a timely fashion.
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.
2-2 The IRS
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
a) Shea resides in the 2nd
based on the
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onlyCircuit,
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and the
following
is single.
has2nd
She alternative
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
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the formation, reorganization, and liquidation of corporations.
Unique to this series is a complete chapter on accounting for in-
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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
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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
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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
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Valeriya Avdeev, William Paterson University Cindy Bortman Boggess, Babson College
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xviii
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xix
Another random document with
no related content on Scribd:
 3

When Lady Molly heard this theory she laughed, and shrugged her
pretty shoulders.
“Old Mr. Frewin was dying, was he not, at the time of the
burglary?” she said. “Why should his wife, soon to become his
widow, take the trouble to go through a laboured and daring comedy
of a burglary in order to possess herself of things which would
become hers within the next few hours? Even if, after Mr. Frewin’s
death, she could not actually dispose of the miniatures, the old man
left her a large sum of money and a big income by his will, with
which she could help her spendthrift son as much as she pleased.”
This was, of course, why the mystery in this strange case was so
deep. At the Yard they did all that they could. Within forty-eight hours
they had notices printed in almost every European language, which
contained rough sketches of the stolen miniatures hastily supplied by
Mrs. Frewin herself. These were sent to as many of the great
museums and art collectors abroad as possible, and of course to the
principal American cities and to American millionaires. There is no
doubt that the thief would find it very difficult to dispose of the
miniatures, and until he could sell them his booty would, of course,
not benefit him in any way. Works of art cannot be tampered with, or
melted down or taken to pieces, like silver or jewellery, and, so far as
could be ascertained, the thief did not appear to make the slightest
attempt to dispose of the booty, and the mystery became more dark,
more impenetrable than ever.
“Will you undertake the job?” said the chief one day to Lady Molly.
“Yes,” she replied, “on two distinct conditions.”
“What are they?”
“That you will not bother me with useless questions, and that you
will send out fresh notices to all the museums and art collectors you
can think of, and request them to let you know of any art purchases
they may have made within the last two years.”
“The last two years!” ejaculated the chief, “why, the miniatures
were only stolen three months ago.”
 “Did I not say that you were not to ask me useless questions?”
This to the chief, mind you; and he only smiled, whilst I nearly fell
backwards at her daring. But he did send out the notices, and it was
generally understood that Lady Molly now had charge of the case.
 4

It was about seven weeks later when, one morning, I found her at
breakfast looking wonderfully bright and excited.
“The Yard has had sheaves of replies, Mary,” she said gaily, “and
the chief still thinks I am a complete fool.”
“Why, what has happened?”
“Only this, that the art museum at Budapest has now in its
possession a set of eight miniatures by Engleheart; but the
authorities did not think that the first notices from Scotland Yard
could possibly refer to these, as they had been purchased from a
private source a little over two years ago.”
“But two years ago the Frewin miniatures were still at Blatchley
House, and Mr. Frewin was fingering them daily,” I said, not
understanding, and wondering what she was driving at.
“I know that,” she said gaily, “so does the chief. That is why he
thinks that I am a first-class idiot.”
“But what do you wish to do now?”
“Go to Brighton, Mary, take you with me and try to elucidate the
mystery of the Frewin miniatures.”
“I don’t understand,” I gasped, bewildered.
“No, and you won’t until we get there,” she replied, running up to
me and kissing me in her pretty, engaging way.
That same afternoon we went to Brighton and took up our abode
at the Hotel Metropole. Now you know I always believed from the
very first that she was a born lady and all the rest of it, but even I
was taken aback at the number of acquaintances and smart friends
she had all over the place. It was “Hello, Lady Molly! whoever would
have thought of meeting you here?” and “Upon my word! this is good
luck,” all the time.
She smiled and chatted gaily with all the folk as if she had known
them all her life, but I could easily see that none of these people
knew that she had anything to do with the Yard.
Brighton is not such a very big place as one would suppose, and
most of the fashionable residents of the gay city find their way
sooner or later to the luxurious dining-room of the Hotel Metropole, if
only for a quiet little dinner given when the cook is out. Therefore I
was not a little surprised when, one evening, about a week after our
arrival and just as we were sitting down to the table d’hôte dinner,
Lady Molly suddenly placed one of her delicate hands on my arm.
“Look behind you, a little to your left, Mary, but not just this minute.
When you do you will see two ladies and two gentlemen sitting at a
small table quite close to us. They are Sir Michael and Lady Steyne,
the Honourable Mrs. Frewin in deep black, and her son, Mr. Lionel
Frewin.”
I looked round as soon as I could, and gazed with some interest at
the hero and heroine of the Blatchley House drama. We had a quiet
little dinner, and Lady Molly having all of a sudden become very
silent and self-possessed, altogether different from her gay, excited
self of the past few days, I scented that something important was in
the air, and tried to look as unconcerned as my lady herself. After
dinner we ordered coffee, and as Lady Molly strolled through into the
lounge, I noticed that she ordered our tray to be placed at a table
which was in very close proximity to one already occupied by Lady
Steyne and her party.
Lady Steyne, I noticed, gave Lady Molly a pleasant nod when we
first came in, and Sir Michael got up and bowed, saying “How d’ye
do?” We sat down and began a desultory conversation together.
Soon, as usual, we were joined by various friends and
acquaintances who all congregated round our table and set
themselves to entertaining us right pleasantly. Presently the
conversation drifted to art matters, Sir Anthony Truscott being there,
who is, as you know, one of the keepers of the Art Department at
South Kensington Museum.
“I am crazy about miniatures just now,” said Lady Molly in
response to a remark from Sir Anthony.
I tried not to look astonished.
“And Miss Granard and I,” continued my lady, quite unblushingly,
“have been travelling all over the Continent in order to try and secure
some rare specimens.”
“Indeed,” said Sir Anthony. “Have you found anything very
wonderful?”
 “We certainly have discovered some rare works of art,” replied
Lady Molly, “have we not, Mary? Now the two Englehearts we
bought at Budapest are undoubtedly quite unique.”
“Engleheart—and at Budapest!” remarked Sir Anthony. “I thought I
knew the collections at most of the great Continental cities, but I
certainly have no recollection of such treasures in the Hungarian
capital.”
“Oh, they were only purchased two years ago, and have only been
shown to the public recently,” remarked Lady Molly. “There was
originally a set of eight, so the comptroller, Mr. Pulszky, informed me.
He bought them from an English collector whose name I have now
forgotten, and he is very proud of them, but they cost the country a
great deal more money than it could afford, and in order somewhat
to recoup himself Mr. Pulszky sold two out of the eight at, I must say,
a very stiff price.”
While she was talking I could not help noticing the strange glitter in
her eyes. Then a curious smothered sound broke upon my ear. I
turned and saw Mrs. Frewin looking with glowing and dilated eyes at
the charming picture presented by Lady Molly.
“I should like to show you my purchases,” said the latter to Sir
Anthony. “One or two foreign connoisseurs have seen the two
miniatures and declare them to be the finest in existence. Mary,” she
added, turning to me, “would you be so kind as to run up to my room
and get me the small sealed packet which is at the bottom of my
dressing-case? Here are the keys.”
A little bewildered, yet guessing by her manner that I had a part to
play, I took the keys from her and went up to her room. In her
dressing-case I certainly found a small, square, flat packet, and with
that in my hand I prepared to go downstairs again. I had just locked
the bedroom door when I was suddenly confronted by a tall, graceful
woman dressed in deep black, whom I at once recognised as the
Honourable Mrs. Frewin.
“You are Miss Granard?” she said quickly and excitedly; her voice
was tremulous and she seemed a prey to the greatest possible
excitement. Without waiting for my reply she continued eagerly:
“Miss Granard, there is no time to be more explicit, but I give you
my word, the word of a very wretched, heart-broken woman, that my
very life depends upon my catching a glimpse of the contents of the
parcel that you now have in your hand.”
“But——” I murmured, hopelessly bewildered.
“There is no ‘but,’ ” she replied. “It is a matter of life and death.
Here are £200, Miss Granard, if you will let me handle that packet,”
and with trembling hands she drew a bundle of bank-notes from her
reticule.
I hesitated, not because I had any notion of acceding to Mrs.
Frewin’s request, but because I did not quite know how I ought to act
at this strange juncture, when a pleasant, mellow voice broke in
suddenly:
“You may take the money, Mary, if you wish. You have my
permission to hand the packet over to this lady,” and Lady Molly,
charming, graceful and elegant in her beautiful directoire gown,
stood smiling some few feet away, with Hankin just visible in the
gloom of the corridor.
She advanced towards us, took the small packet from my hands,
and held it out towards Mrs. Frewin.
“Will you open it?” she said, “or shall I?”
Mrs. Frewin did not move. She stood as if turned to stone. Then
with dexterous fingers my lady broke the seals of the packet and
drew from it a few sheets of plain white cardboard and a thin piece of
match-boarding.
“There!” said Lady Molly, fingering the bits of cardboard while she
kept her fine large eyes fixed on Mrs. Frewin; “£200 is a big price to
pay for a sight of these worthless things.”
“Then this was a vulgar trick,” said Mrs. Frewin, drawing herself up
with an air which did not affect Lady Molly in the least.
“A trick, certainly,” she replied with her winning smile, “vulgar, if
you will call it so—pleasant to us all, Mrs. Frewin, since you so
readily fell into it.”
“Well, and what are you going to do next?”
“Report the matter to my chief,” said Lady Molly, quietly. “We have
all been very severely blamed for not discovering sooner the truth
about the disappearance of the Frewin miniatures.”
“You don’t know the truth now,” retorted Mrs. Frewin.
 “Oh, yes, I do,” replied Lady Molly, still smiling. “I know that two
years ago your son, Mr. Lionel Frewin, was in terrible monetary
difficulties. There was something unavowable, which he dared not
tell his father. You had to set to work to find money somehow. You
had no capital at your own disposal, and you wished to save your
son from the terrible consequences of his own folly. It was soon after
M. de Colinville’s visit. Your husband had had his first apoplectic
seizure; his mind and eyesight were somewhat impaired. You are a
clever artist yourself, and you schemed out a plan whereby you
carefully copied the priceless miniatures and then entrusted them to
your son for sale to the Art Museum at Budapest, where there was
but little likelihood of their being seen by anyone who knew they had
belonged to your husband. English people do not stay more than
one night there, at the Hotel Hungaria. Your copies were works of art
in themselves, and you had no difficulty in deceiving your husband in
the state of mind he then was, but when he lay dying you realised
that his will would inevitably be proved, wherein he bequeathed the
miniatures to Mr. James Hyam, and that these would have to be
valued for probate. Frightened now that the substitution would be
discovered, you devised the clever comedy of the burglary at
Blatchley, which, in the circumstances, could never be brought home
to you or your son. I don’t know where you subsequently concealed
the spurious Engleheart miniatures which you calmly took out of the
library and hid away during the night of your husband’s death, but no
doubt our men will find that out,” she added quietly, “now that they
are on the track.”
With a frightened shriek Mrs. Frewin turned as if she would fly, but
Lady Molly was too quick for her, and barred the way. Then, with that
wonderful charm of manner and that innate kindliness which always
characterised her, she took hold of the unfortunate woman’s wrist.
“Let me give you a word of advice,” she said gently. “We at the
Yard will be quite content with a confession from you, which will clear
us of negligence and satisfy us that the crime has been brought
home to its perpetrator. After that try and enter into an arrangement
with your husband’s legatee, Mr. James Hyam. Make a clean breast
of the whole thing to him and offer him full monetary compensation.
For the sake of the family he won’t refuse. He would have nothing to
gain by bruiting the whole thing abroad; and for his own sake and
that of his late uncle, who was so good to him, I don’t think you
would find him hard to deal with.”
Mrs. Frewin paused awhile, undecided and still defiant. Then her
attitude softened; she turned and looked full at the beautiful, kind
eyes turned eagerly up to hers, and pressing Lady Molly’s tiny hand
in both her own she whispered:
“I will take your advice. God bless you.”
She was gone, and Lady Molly called Hankin to her side.
“Until we have that confession, Hankin,” she said, with the quiet
manner she always adopted where matters connected with her work
were concerned, “Mum’s the word.”
“Ay, and after that, too, my lady,” replied Hankin, earnestly.
You see, she could do anything she liked with the men, and I, of
course, was her slave.
Now we have got the confession, Mrs. Frewin is on the best of
terms with Mr. James Hyam, who has behaved very well about the
whole thing, and the public has forgotten all about the mystery of the
Frewin miniatures.
 III.
THE IRISH-TWEED COAT

It all began with the murder of Mr. Andrew Carrthwaite, at Palermo.

He had been found dead in the garden of his villa just outside the
town, with a stiletto between his shoulder blades and a piece of
rough Irish tweed, obviously torn from his assailant’s coat, clutched
tightly in his hand.
All that was known of Mr. Carrthwaite over here was that he was a
Yorkshireman, owner of some marble works in Sicily, a man who
employed a great many hands; and that, unlike most employers of
labour over there, he had a perfect horror of the many secret
societies and Socialist clubs which abound in that part of the world.
He would not become a slave to the ever-growing tyranny of the
Mafia and its kindred associations, and therefore he made it a hard
and fast rule that no workman employed by him, from the foremost to
the meanest hand, should belong to any society, club, or trade union
of any sort or kind.
At first, robbery was thought to have been the sole object of the
crime, for Mr. Carrthwaite’s gold watch, marked with his initials
“A. C.,” and his chain were missing, but the Sicilian police were soon
inclined to the belief that this was merely a blind, and that personal
spite and revenge were at the bottom of that dastardly outrage.
One clue, remember, had remained in the possession of the
authorities. This was the piece of rough Irish tweed, found in the
murdered man’s hand.
Within twenty-four hours a dozen witnesses were prepared to
swear that that fragment of cloth was part of a coat habitually worn
by Mr. Carrthwaite’s English overseer, Mr. Cecil Shuttleworth. It
appears that this young man had lately, in defiance of the rigid rules
prescribed by his employer, joined a local society—semi-social,
semi-religious—which came under the ban of the old Yorkshireman’s
prejudices.
 Apparently there had been several bitter quarrels between Mr.
Carrthwaite and young Shuttleworth, culminating in one tempestuous
scene, witnessed by the former’s servants at his villa; and although
these people did not understand the actual words that passed
between the two Englishmen, it was pretty clear that they amounted
to an ultimatum on the one side and defiance on the other. The
dismissal of the overseer followed immediately, and that same
evening Mr. Carrthwaite was found murdered in his garden.
Mind you—according to English ideas—the preliminary
investigations in that mysterious crime were hurried through in a
manner which we should think unfair to the accused. It seemed from
the first as if the Sicilian police had wilfully made up their minds that
Shuttleworth was guilty. For instance, although

“He had been found dead in the garden of his villa”

so many people were prepared to swear that the young English
overseer had often worn a coat of which the piece found in the
murdered man’s hand was undoubtedly a torn fragment, yet the coat
itself was not found among his effects, neither were his late master’s
watch and chain.
Nevertheless, the young man was arrested within a few hours of
the murder, and—after the formalities of the preliminary
“instruction”—was duly committed to stand his trial on the capital
charge.
It was about this time that I severed my official connection with the
Yard. Lady Molly now employed me as her private secretary, and I
was working with her one day in the study of our snug little flat in
Maida Vale, when our trim servant came in to us with a card and a
letter on a salver.
Lady Molly glanced at the card, then handed it across to me. It
bore the name: Mr. Jeremiah Shuttleworth.
The letter was from the chief.
“Not much in it,” she commented, glancing rapidly at its contents.
“The chief only says, ‘This is the father of the man who is charged
with the Palermo murder. As obstinate as a mule, but you have my
permission to do what he wants.’ Emily, show the gentleman in,” she
added.
The next moment a short, thick-set man entered our little study. He
had sandy hair and a freckled skin; there was a great look of
determination in the square face and a fund of dogged obstinacy in
the broad, somewhat heavy jaw. In response to Lady Molly’s
invitation he sat down and began with extraordinary abruptness:
“I suppose you know what I have come about—er—miss?” he
suggested.
“Well!” she replied, holding up his own card, “I can guess.”
“My son, miss—I mean ma’am,” he said in a husky voice. “He is
innocent. I swear it by the living——”
He checked himself, obviously ashamed of this outburst; then he
resumed more calmly.
“Of course, there’s the business about the coat, and that coat did
belong to my son, but——”
 “Well, yes?” asked Lady Molly, for he had paused again, as if
waiting to be encouraged in his narrative, “what about that coat?”
“It has been found in London, miss,” he replied quietly. “The
fiendish brutes who committed the crime thought out this monstrous
way of diverting attention from themselves by getting hold of my
son’s coat and making the actual assassin wear it, in case he was
espied in the gloom.”
There was silence in the little study for awhile. I was amazed,
aghast at the suggestion put forward by that rough north-
countryman, that sorely stricken father who spoke with curious
intensity of language and of feeling. Lady Molly was the first to break
the solemn silence.
“What makes you think, Mr. Shuttleworth, that the assassination of
Mr. Carrthwaite was the work of a gang of murderers?” she asked.
“I know Sicily,” he replied simply. “My boy’s mother was a native of
Messina. The place is riddled with secret societies, murdering,
anarchical clubs: organisations against which Mr. Carrthwaite waged
deadly warfare. It is one of these—the Mafia, probably—that decreed
that Mr. Carrthwaite should be done away with. They could not do
with such a powerful and hard-headed enemy.”
“You may be right, Mr. Shuttleworth, but tell me more about the
coat.”
“Well, that’ll be damning proof against the blackguards, anyway. I
am on the eve of a second marriage, miss—ma’am,” continued the
man with seeming irrelevance. “The lady is a widow. Mrs. Tadworth
is her name—but her father was an Italian named Badeni, a
connection of my first wife’s, and that’s how I came to know him and
his daughter. You know Leather Lane, don’t you? It might be in Italy,
for Italian’s the only language one hears about there. Badeni owned
a house in Bread Street, Leather Lane, and let lodgings to his fellow-
countrymen there; this business my future wife still carries on. About
a week ago two men arrived at the house, father and son, so they
said, who wanted a cheap bedroom; all their meals, including
breakfast, they would take outside, and would be out, moreover,
most of the day.
“It seems that they had often lodged at Badeni’s before—the old
reprobate no doubt was one of their gang—and when they
understood that Mrs. Tadworth was their former friend’s daughter
they were quite satisfied.
“They gave their name as Piatti, and told Mrs. Tadworth that they
came from Turin. But I happened to hear them talking on the stairs,
and I knew that they were Sicilians, both of them.
“You may well imagine that just now everything hailing from Sicily
is of vital importance to me, and somehow I suspected those two
men from the very first. Mrs. Tadworth is quite at one with me in
wanting to move heaven and earth to prove the innocence of my
boy. She watched those people for me as a cat would watch a
mouse. The older man professed to be very fond of gardening, and
presently he obtained Mrs. Tadworth’s permission to busy himself in
the little strip of barren ground at the back of the house. This she told
me last night whilst we were having supper together in her little
parlour. Somehow I seemed to get an inspiration like. The Piattis had
gone out together as usual for their evening meal. I got a spade and
went out into the strip of garden. I worked for about an hour, and
then my heart gave one big leap—my spade had met a certain
curious, soft resistance—the next moment I was working away with
hands and nails, and soon unearthed a coat—the coat, miss,” he
continued, unable now to control his excitement, “with the bit torn out
of the back, and in the pocket the watch and chain belonging to the
murdered man, for they bear the initials ‘A. C.’ The fiendish brutes! I
knew it—I knew it, and now I can prove the innocence of my boy!”
Again there was a pause. I was too much absorbed in the
palpitating narrative to attempt to breathe a word, and I knew that
Lady Molly was placidly waiting until the man had somewhat
recovered from his vehement outburst.
“Of course, you can prove your boy’s innocence now,” she said,
smiling encouragingly into his flushed face. “But what have you done
with the coat?”
“Left it buried where I found it,” he replied more calmly. “They must
not suspect that I am on their track.”
She nodded approvingly.
“No doubt, then, my chief has told you that the best course to
pursue now will be to place the whole matter in the hands of the
English police. Our people at Scotland Yard will then immediately
communicate with the Sicilian authorities, and in the meanwhile we
can keep the two men in Leather Lane well under surveillance.”
“Yes, he told me all that,” said Mr. Shuttleworth, quietly.
“Well?”
“And I told him that his ‘communicating with the Sicilian police
authorities’ would result in my boy’s trial being summarily concluded,
in his being sent to the gallows, whilst every proof of his innocence
would be destroyed, or, at any rate, kept back until too late.”
“You are mad, Mr. Shuttleworth!” she ejaculated.
“Maybe I am,” he rejoined quietly. “You see, you do not know
Sicily, and I do. You do not know its many clubs and bands of
assassins, beside whom the so-called Russian Nihilists are simple,
blundering children. The Mafia, which is the parent of all such
murderous organisations, has members and agents in every town,
village, and hamlet in Italy, in every post-office and barracks, in every
trade and profession from the highest to the lowest in the land. The
Sicilian police force is infested with it, so are the Italian customs. I
would not trust either with what means my boy’s life and more to
me.”
“But——”
“The police would suppress the evidence connected with the
proofs which I hold. At the frontier the coat, the watch and chain
would disappear; of that I am as convinced as that I am a living man
——”
Lady Molly made no comment. She was meditating. That there
was truth in what the man said, no one could deny.
The few details which we had gleaned over here of the hurried
investigations, the summary commitment for trial of the accused, the
hasty dismissal of all evidence in his favour, proved that, at any rate,
the father’s anxiety was well founded.
“But, then, what in the world do you propose to
 “ ‘Well,’ said Lady Molly, ‘… what is it that you want us to do in the
matter?’ ”

do?” said Lady Molly after a while. “Do you want to take the proofs
over yourself to your boy’s advocate? Is that it?”
“No, that would be no good,” he replied simply. “I am known in
Sicily. I should be watched, probably murdered, too, and my death
would not benefit my boy.”
“But what then?”
“My boy’s uncle is chief officer of police at Cividale, on the Austro-
Italian frontier. I know that I can rely on his devotion. Mrs. Tadworth,
whose interest in my boy is almost equal to my own, and whose
connection with me cannot possibly be known out there, will take the
proofs of my boy’s innocence to him. He will know what to do and
how to reach my son’s advocate safely, which no one else could
guarantee to do.”
 “Well,” said Lady Molly, “that being so, what is it that you want us
to do in the matter?”
“I want a lady’s help, miss—er—ma’am,” he replied, “someone
who is able, willing, strong, and, if possible, enthusiastic, to
accompany Mrs. Tadworth—perhaps in the capacity of a maid—just
to avert the usual suspicious glances thrown at a lady travelling
alone. Also the question of foreign languages comes in. The
gentleman I saw at Scotland Yard said that if you cared to go he
would give you a fortnight’s leave of absence.”
“Yes, I’ll go!” rejoined Lady Molly, simply.
 2

We sat in the study a long while after that—Mr. Shuttleworth, Lady

Molly and I—discussing the plans of the exciting journey; for I, too,
as you will see, was destined to play my small part in this drama
which had the life or death of an innocent man for its dénouement.
I don’t think I need bore you with an account of our discussion; all,
I think, that will interest you is the plan of campaign we finally
decided upon.
There seemed to be no doubt that Mr. Shuttleworth had
succeeded so far in not arousing the suspicions of the Piattis.
Therefore, that night, when they were safely out of the way, Mr.
Shuttleworth would once more unearth the coat, and watch and
chain, and then bury a coat quite similar in colour and texture in that
same hole in the ground; this might perhaps serve to put the
miscreants off their guard, if by any chance one of them should busy
himself again in the garden.
After that Mrs. Tadworth would hide about her the proofs of young
Shuttleworth’s innocence and join Lady Molly at our flat in Maida
Vale, where she would spend the night preparatory to the two ladies
leaving London for abroad, the following morning, by the 9.0 a.m.
train from Charing Cross en route for Vienna, Budapest, and finally
Cividale.
But our scheme was even more comprehensive than that, and
herein lay my own little share in it, of which I will tell you presently.
The same evening at half-past nine Mrs. Tadworth arrived at the
flat with the coat, and watch and chain, which were to be placed in
the hands of Colonel Grassi, the chief police officer at Cividale.
I took a keen look at the lady, you may be sure of that. It was a
pretty little face enough, and she herself could not have been much
more than seven or eight and twenty, but to me the whole
appearance and manner of the woman suggested weakness of
character, rather than that devotion on which poor Mr. Shuttleworth
so implicitly relied.
 I suppose that it was on that account that I felt unaccountably
down-hearted and anxious when I bade farewell to my own dear lady
—a feeling in which she obviously did not share. Then I began to
enact the rôle which had been assigned to me.
I dressed up in Mrs. Tadworth’s clothes—we were about the same
height—and putting on her hat and closely fitting veil, I set out for
Leather Lane. For as many hours as I could possibly contrive to
keep up the deception, I was to impersonate Mrs. Tadworth in her
own house.
As I dare say you have guessed by now, that lady was not in
affluent circumstances, and the house in a small by-street off Leather
Lane did not boast of a staff of servants. In fact, Mrs. Tadworth did all
the domestic work herself, with the help of a charwoman for a couple
of hours in the mornings.
That charwoman had, in accordance with Lady Molly’s plan, been
given a week’s wages in lieu of notice. I—as Mrs. Tadworth—would
be supposed the next day to be confined to my room with a cold, and
Emily—our own little maid, a bright girl, who would go through fire
and water for Lady Molly or for me—would represent a new
charwoman.
As soon as anything occurred to arouse my suspicions that our
secret had been discovered, I was to wire to Lady Molly at the
various points which she gave me.
Thus provided with an important and comprehensive part, I duly
installed myself at Bread Street, Leather Lane. Emily—who had
been told just enough of the story, and no more, to make her eager,
excited and satisfied—entered into the spirit of her rôle as eagerly as
I did myself.
That first night was quite uneventful. The Piattis came home some
time after eleven and went straight up to their room.
Emily, looking as like a bedraggled charwoman as her trim figure
would allow, was in the hall the next morning when the two men
started off for breakfast. She told me afterwards that the younger
one looked at her very keenly, and asked her why the other servant
had gone. Emily replied with due and proper vagueness, whereupon
the Sicilians said no more and went out together.
 That was a long and wearisome day which I spent cooped up in
the tiny, stuffy parlour, ceaselessly watching the tiny patch of ground
at the back, devoured with anxiety, following the travellers in my
mind on their way across Europe.
Towards midday one of the Piattis came home and presently
strolled out into the garden. Evidently the change of servants had
aroused his suspicions, for I could see him feeling about the earth
with his spade and looking up now and again towards the window of
the parlour, whereat I contrived to show him the form of a pseudo
Mrs. Tadworth moving about the room.
Mr. Shuttleworth and I were having supper in that same back
parlour at about nine o’clock on that memorable evening, when we
suddenly heard the front door being opened with a latchkey, and
then very cautiously shut again.
One of the two men had returned at an hour most unusual for their
otherwise very regular habits. The way, too, in which the door had
been opened and shut suggested a desire for secrecy and silence.
Instinctively I turned off the gas in the parlour, and with a quick
gesture pointed to the front room, the door of which stood open, and
I whispered hurriedly to Mr. Shuttleworth.
“Speak to him!”
Fortunately, the great aim which he had in view had rendered his
perceptions very keen.
He went into the front room, in which the gas, fortunately, was
alight at the time, and opening the door which gave thence on to the
passage, he said pleasantly:
“Oh, Mr. Piatti! is that you? Can I do anything for you?”
“Ah, yes! zank you,” replied the Sicilian, whose voice I could hear
was husky and unsteady, “if you would be so kind—I—I feel so
fainting and queer to-night—ze warm weazer, I zink. Would you—
would you be so kind to fetch me a little—er—ammoniac—er—sal
volatile you call it, I zink—from ze apothecary? I would go lie on my
bed—if you would be so kind——”
“Why, of course I will, Mr. Piatti,” said Mr. Shuttleworth, who
somehow got an intuition of what I wanted to do, and literally played
into my hands. “I’ll go at once.”
 He went to get his hat from the rack in the hall whilst the Sicilian
murmured profuse “Zank you’s,” and then I heard the front door bang
to.
From where I was I could not see Piatti, but I imagined him
standing in the dimly-lighted passage listening to Mr. Shuttleworth’s
retreating footsteps.
Presently I heard him walking along towards the back door, and
soon I perceived something moving about in the little bit of ground
beyond. He had gone to get his spade. He meant to unearth the coat
and the watch and chain which, for some reason or another, he must
have thought were no longer safe in their original hiding-place. Had
the gang of murderers heard that the man who frequently visited
their landlady was the father of Cecil Shuttleworth over at Palermo?
At that moment I paused neither to speculate nor yet to plan. I ran
down to the kitchen, for I no longer wanted to watch Piatti. I knew
what he was doing.
I didn’t want to frighten Emily, and she had been made to
understand all along that she might have to leave the house with me
again at any time, at a moment’s notice; she and I had kept our small
handbag ready packed in the kitchen, whence we could reach the
area steps quickly and easily.
Now I quietly beckoned to her that the time had come. She took
the bag and followed me. Just as we shut the area gate behind us,
we heard the garden door violently slammed. Piatti had got the coat,
and by now was examining the pockets in order to find the watch
and chain. Within the next ten seconds he would realise that the coat
which he held was not the one which he had buried in the garden,
and that the real proofs of his guilt—or his complicity in the guilt of
another—had disappeared.
We did not wait for those ten seconds, but flew down Bread Street,
in the direction of Leather Lane, where I knew Mr. Shuttleworth
would be on the lookout for me.
“Yes,” I said hurriedly, directly I spied him at the angle of the street;
“it’s all up. I am off to Budapest by the early Continental to-morrow
morning. I shall catch them at the Hungaria. See Emily safely to the
flat.”