Assume a business makes and sells widgets. Giant Widgets is a sole proprietorship, so the owner's individual and business finances are merged. The owner is single, without dependents, and has a part-time job elsewhere which earns him $10,000 a year with $1000 withheld for federal income taxes.

The following information is available for the business:

Gross income for the 1000 widgets sold last year for $100 each, equals $100,000. (Use this figure in filling out schedule C, part I.) Assume the firm has competition and is a price taker (i.e., perfect competition).

Wages for each of the two part-time workers (no benefits are paid for them), $20,000, for a total of $40,000.

Supplies in producing those 1000 units, $4000.

Rent $16,000

Insurance $1000

Advertising $1000

Repairs and maintenance on equipment $500

Allowable depreciation on equipment, $2000

Utilities, $500

Office expenses such as postage, $1000

License fees (assume this is a yearly payment to the county for the privilege of doing business there), $500

Legal and accounting services, $1500

Do each of the following parts of the assignment. Only the first part requires income tax forms; the other parts can be done even if these forms are not filled out. It will be easiest for both you and me if you turn in a hard copy of this project at some in-person class meeting. If this doesn't work for you, you will have to create a PDF file and submit it on line, either on D2L or in an email. But I will warn you that I have often encountered attachments which do not open, for reasons unknown, so there could be technical problems with doing it this way.

I. Go to www.irs.gov. Print out form 1040, schedules 1 and 2, schedule C (not C-EZ), and Schedule SE. Fill these out for the owner/his business. How much federal tax does he owe now?

Do not obsess over getting everything entered in the proper space. In particular, you can omit identifying information like address, tax ID numbers, and industry code. Just get the numbers down. You can round to the nearest dollar. On Schedule C, you can ignore parts III, IV and V. But if you enter a number for cost of goods sold in Part I, do NOT duplicate those expenses in Part II! (I don't care whether you do a cost of goods sold or count all expenses in part II).

I am trying to reduce this tax problem to bare bones, so I will save you a bit of effort: while in reality under current law you would need to also file form 8995, I will tell you that the qualified business income deduction will be 20% of taxable income before subtracting qualified business income (in other words, 20% of [AGI - standard/itemized deduction]) so you need not worry about what comprises qualified business income or filling out form 8995.

On Schedule SE: unfortunately, this year the IRS did away with the short form. The long form is rather confusing. However, the substance is unchanged, and here is how you can check your answer: (1) Multiply net profit by 0.9235. (2) Multiply what you got in (1) by 0.153. This is the same number you will enter on line 12 of Schedule SE. And remember that the self employment tax is an ADDITIONAL tax, meant to replace the medicare and social security tax which for employees is deducted from their paychecks. It does NOT replace the tax computed on the rest of one's income on the 1040! Also, don't forget to take an adjustment on the 1040 for half of the SE tax.

Taxpayer will not qualify for the Earned Income Credit, and he has no investment or other income except for that part-time job and his business. Also assume that taxpayer will have no rebate recovery credit. Expect to have a lot of blank spaces on the forms, and don't assume anything not given to you unless it is on the form itself (which a few essential things are). It will be a good idea to consult the instructions for these forms. Do not panic or look for complications; my goal is to see that you have a generally correct idea (and the bottom line should not be too hard to find), not that every detail be done correctly.

II. Do not redo the tax forms for these questions; you can answer these without reference to any answers from part I.

a) Is the taxable business profit you found equal to, greater than, or less than the firm's actual profit as reflected in its bank balance, AND WHY?

b) What difference would it make if the firm was able to deduct depreciation over a shorter period of time (that is, deduct a larger amount each year for fewer years total)? This is a general question, not specific to your facts in this problem.

c) Suppose the landlord raises the rent to $20,000. What effect would this have on the firm's profit and output level, AND WHY?

III. Suppose the firm considers hiring 1 more worker at a cost of $20,000. Assume this would add 500 units to output production and, at the current price, add $50,000 to revenue. It would also add the following to existing production costs:

Supply cost for additional output $2000

Utilities (mainly electricity) $250

Renting an extra room $9000

Office expenses $750

Lease (not buy) a new machine $3000

Do not redo the tax forms; assume for this problem no tax consequences.

a) What is marginal cost?

b) Would it be beneficial for the firm to undertake this expansion? WHY OR WHY NOT?

IV. Again, you do not need tax forms for these questions.

a) In Part I, which costs are fixed and which are variable? Explain.

b) In Part III, how (AND WHY) might the output decision change if

i) the market price per unit had decreased to $45,

II) the market price per unit was $65.

V. How (AND WHY) does the government influence individual consumer behavior through the tax code (in other words, making a given choice more or less expensive for the individual)? Go back to the IRS site; look at the 1040 and its numbered schedules and give 2 examples. This is not limited to the business context. For each, identify what instance of market failure (positive or negative externality) is being addressed, as well as the desired effect of the tax treatment.