Chapter 05 Gross Income and Exclusions True / False Questions Gross income includes all income realized during the year True False Excluded income will never be subject to the federal income tax True False The all-inclusive definition of income means that gross income is defined very broadly True False A taxpayer who borrows money will include that amount borrowed in their gross income under the all-inclusive definition of income True False Income is included in gross income unless a tax provision specifies that it can be deferred or excluded True False The principle of realization for tax purposes is very different from realization as it is understood for financial reporting purposes True False Wherewithal to pay represents the principle that a realized transaction should require a taxpayer to sell other assets in order to pay income taxes True False Barter clubs are an effective means of avoiding realization for tax purposes True False The cash method of accounting requires taxpayers to recognize income only when that income is received as cash True False 5-1 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 10 When a carpenter provides $100 of services in exchange for $100 of groceries, the carpenter has realized $100 of income True False 11 Recognized income may be in the form of cash or property received (but not services received) True False 12 When a taxpayer sells an asset, the entire proceeds from the sale must be included in gross income regardless of the cost of the asset True False 13 Jake sold his car for $2,400 in cash this year He will realize a taxable gain of $1,000 if he purchased the car for $1,400 True False 14 When an asset is sold, the taxpayer calculates the gain or loss by subtracting the tax basis of the asset from the proceeds of the sale True False 15 The tax benefit rule applies when a taxpayer refunds amounts that were previously included in income True False 16 Jim received a $500 refund of state income taxes this year Jim will not need to include the $500 in his gross income this year because he did not deduct state income taxes last year True False 17 Constructive receipt represents the principle that cash basis taxpayers should be taxed on income when it is made available to them without substantial restrictions True False 18 Claim of right states that income has been realized if a taxpayer receives income and there are substantial restrictions on the taxpayer's use of the income True False 19 Community property laws dictate that income earned by one spouse is treated as though it was earned equally by both spouses True False 20 Interest income is earned in the year in which it is received by the taxpayer or credited to the bank account True False 5-2 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 21 The assignment of income doctrine requires that to shift income from property to another person, the taxpayer must transfer only the income to the other person True False 22 For tax purposes, unearned income means income that has not yet been realized True False 23 A portion of each payment from a purchased annuity represents income True False 24 The exclusion ratio for a purchased annuity is the cost of the annuity divided by the interest rate True False 25 Rental income generated by a partnership is reported by partners as dividend income True False 26 The tax law defines alimony to include transfers of property (but not cash) between former spouses True False 27 The tax law includes a complex set of restrictions called the anti-frontloading rules to make it difficult for taxpayers to disguise property payments as alimony payments True False 28 Prizes and awards are generally taxable True False 29 Gambling winnings are included in gross income only to the extent that the winnings exceed gambling losses incurred during the same period True False 30 Generally, 85 percent of Social Security benefits are included in income of high income taxpayers True False 31 Unemployment benefits are excluded from gross income True False 32 A taxpayer generally includes in gross income the amount of debt forgiven by a lender True False 5-3 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 33 An employee may exclude up to a 40 percent employer-provided discount on services True False 34 A below-market loan (e.g., from an employer to an employee) is a common example of a transaction that generates taxable imputed income True False 35 Interest earned on a Federal Treasury bond is excluded from gross income (for federal tax purposes) True False 36 Interest earned on a city of Denver bond is excluded from gross income (for federal tax purposes) True False 37 Taxpayers meeting certain home ownership and use requirements can permanently exclude up to $1,000,000 of realized gain on the sale of their principal residence True False 38 Qualified fringe benefits received by an employee can be excluded from gross income True False 39 Scholarships are excluded from gross income for degree candidates even if the scholarship pays for required fees and books in addition to tuition True False 40 Earnings from 529 plans and Coverdell education savings accounts are excluded from gross income as long as they use the earnings to pay for qualifying educational expenditures True False 41 Trevor received a gift of $25,000 in cash from his rich uncle Trevor must include $15,000 of this gift in his gross income this year True False 42 Anna received $15,000 from life insurance paid upon the death of her grandmother Anna can exclude the entire amount of the life insurance from her gross income True False 43 U.S citizens generally are subject to tax on all income whether it is generated in the United States or in foreign countries True False 5-4 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 44 To provide relief from double taxation, Congress allows a foreign-unearned income exclusion for interest and dividends earned in foreign countries True False 45 Worker's compensation benefits are excluded from gross income True False 46 Fred must include in gross income a $7,500 payment received from his neighbor to compensate Fred for the emotional distress he suffered when his neighbor accidentally ran over his dog True False 47 Loretta received $6,200 from disability insurance that she purchased directly this year Loretta must include all $6,200 in her gross income True False 48 Brad was disabled for part of the year and he received $11,500 of benefits from a disability plan purchased by Brad's employer Brad must include all $11,500 of benefits in his gross income because Brad was not taxed on the disability insurance premiums paid by his employer True False Multiple Choice Questions 49 Gross income includes A B C D E all income from whatever source derived unless excluded by law all realized inco 50 Which of the following is not a necessary condition for income to be included in gross income? A B C D E income must be realized income must be paid in cash income cannot be excluded by law income must be made available to a taxpayer on the cash basis 5-5 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 51 Sally is a cash basis taxpayer and a member of the Valley Barter club This year Sally provided 100 hours of sewing services to the barter club in exchange for two football playoff tickets Which of the following is a true statement? A B C D E Sally need not recognize any gross income unless she sells the football tickets Sally's exchange does not result in taxable income Sally is taxed on the value of the football tickets even if she cannot attend the Sally is taxed on the value of her sewing services only if she is a professional sea All of these are true 52 This year Barney purchased 500 shares of Bell common stock for $20 per share At year-end the Bell shares were only worth $2 per share What amount can Barney deduct as a loss this year? A B C D E Barney can deduct $10,000 only if he includes $1,000 in his taxable income None of these - Barney is not entitled to a loss deduction 53 Hillary is a cash-basis calendar-year taxpayer During the last week of December she received a letter containing a $5,000 check for services Which of the following is a true statement? A B C D E Hillary is taxed on the $5,000 of service income in the year she cashes the chec Hillary is taxed on the $5,000 of service income in the year the check was maile Hillary is taxed on the $5,000 of service income in the year she receives the ch Hillary is taxed on the $5,000 of service income in the year she provides the se None of these is true 54 Identify the rule that determines whether a taxpayer must include in income a refund of an amount deducted in a previous year: A B C D E Constructive receipt Return of capital principle 55 Identify the rule dictating that on a sale of an asset a taxpayer need only include the incremental gain in gross income rather than the entire proceeds from the sale: A B C D E Constructive receipt Return of capital principle Wherewithal to 5-6 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 56 Identify the rule that states that income has been realized when a taxpayer receives the income and there are no restrictions on the taxpayer's use of the income (e.g., no obligation to repay the amount): A B C D E Constructive receipt Return of capital principle Wherewithal to 57 Dave is a plumber who uses the cash method of accounting This year Dave requested that his clients make their checks payable to his son, Steve This year Steve received checks in the amount of $62,000 for Dave's plumbing services Which of the following is a true statement? A B C D E Dave is taxed on $62,000 of plumbing income this year Steve is taxed on $62,000 of plumbing income this year Steve is taxed on $62,000 of income from gifts received this year Dave may deduct the $62,000 received by Steve All of these are true 58 Jack and Jill are married This year Jack earned $72,000 and Jill earned $80,000 and they received $4,000 of interest income from a joint savings account How much gross income would Jack report if he files married-separate from Jill? A B C D E $72,000 if they reside in a common law state $76,000 if they reside in a community property law state $84,000 if they reside in a common law state $78,000 if they reside in a community property law state 59 Identify which of the items below help determine which taxpayer must recognize earned income: A B C D E Residence in a community property law state Assignment of income Residence in a common law state Both residence in a community property law state and assignment of income a 5-7 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 60 Kevin provided services to several clients this year who paid with different types of property Which of the following payments is not included in Kevin's gross income? A B C D E Shares of stock listed on the New York Stock Exchange All of these are included in gross income 61 Emily is a cash basis taxpayer, and she was an especially productive salesperson last year In December of last year her supervisor told Emily she had earned a $5,000 bonus However, Emily received the bonus check after year end Identify the principle that will determine when Emily is taxed on the bonus: A B C D E Assignment of income Constructive receipt Return of capital principle Wherewithal to 62 Ophra is a cash basis taxpayer who is employed in the publishing industry This year her employer informed her that because of her outstanding performance she is entitled to a free world cruise Ophra asked her employer to issue the cruise tickets to her parents, and he complied with this request Identify the principle that will determine whether Ophra or her parents are taxed on the value of the cruise tickets: A B C D E Assignment of income Constructive receipt Return of capital principle Wherewithal to 63 This year Henry realized a gain on the sale of an antique car that he inherited from his uncle The buyer has promised to pay Henry in installment payments over the next few years Identify the principle that will determine when Henry should be taxed on the gain from the sale: A B C D E Assignment of income Constructive receipt Return of capital principle Wherewithal to 5-8 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 64 This year Mary received a $200 refund of state income taxes that she deducted on her tax return last year Mary included a total of $4,000 of state income taxes when she itemized deductions last year What amount of the refund, if any, should Mary include in her gross income this year? A B C D E $200 is included because Mary itemized her deductions last year $200 is included if itemized deductions exceeded the standard deduction by $2 $200 is included because itemized deductions exceeded the standard deductio $200 is included even if Mary claimed the standard deduction None of these - refunds of state income taxes are not included in gross income 65 Opal deducted $2,400 of state income taxes on her tax return last year This year she received a state income tax refund of $170 What amount of the refund, if any, should Opal include in her gross income if last year her total itemized deductions exceeded the standard deduction by $350? A B C D E None of these - refunds of state income taxes are not included in gross income 66 Wilma has a $25,000 certificate of deposit (CD) at the local bank The interest on this certificate, $1,000, was credited to her account this year but she must pay an early withdrawal penalty if she cashes in the CD before next year Which of the following is a true statement? A B C D E Wilma must include the $1,000 of interest in her income this year Wilma must include the $1,000 of interest in her income when she cashes the C Wilma must include the $1,000 of interest in her income this year only if the bank Wilma must include the $1,000 of interest in her income next year if she does not 67 Which of the following is a true statement about the first payment received from a purchased annuity? A B C D E The payment is included in gross income A portion of the payment is a return of capital The payment can only be taxed in the year after the annuity was purchased The payment is not taxed until the annuity payments cease altogether 5-9 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 68 Which of the following is a description of how the annuity exclusion ratio is calculated for an annuity paid over a fixed period? A B C D E The expected return is divided by the number of payments The original investment is divided by the prevailing interest rate The original investment is divided by the number of payments The expected return is divided by the prevailing interest rate 69 George purchased a life annuity for $3,200 that will provide him $80 monthly payments for as long as he lives Based on IRS tables, George's life expectancy is 100 months How much of the first $80 payment will George include in his gross income? A B C D E 70 Fran purchased an annuity that provides $12,000 quarterly payments for the next 10 years The annuity was purchased at a cost of $300,000 How much of the first quarterly payment will Fran include in her gross income? A B C D E 71 Harold receives a life annuity from his qualified pension that pays him $5,000 per year for as long as he lives Later this year Harold will recover the remainder of his cost of the annuity Which of the following correctly describes how the annuity payments are taxed after Harold has recovered the cost of the annuity? A B C D E Harold will continue to apply the annuity exclusion ratio to determine the amount Harold will include the entire amount of each annuity payment in gross income aft The entire amount of each annuity payment is excluded from gross income after H Harold must request that the IRS calculate his exclusion ratio based upon a revise 5-10 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education sickness are nontaxable Damages taxpayers receive for emotional distress that are not associated with a physical injury are taxable as are punitive damages and damages to reputation AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Medium Topic: Exclusion provisions Essay Questions 105 This year Ann has the following stock transactions What amount is included in her gross income if Ann paid a $200 selling commission for each sale? $2,100 ATT: ($9,500 - $200) - $7,500 = $1,800 Dell ($13,000 - $200) - $12,500 = $300 Feedback: The increase in value in the IBM stock is not yet realized AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-01 Apply the concept of realization and explain when taxpayers recognize gross income Level of Difficulty: Medium Topic: Realization and recognition of income 5-220 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 106 Blake is a limited partner in Kling-On Partners This year Kling-On reported that Blake's share of dividend income was $3,700 and his share of municipal interest was $2,750 Early this year Blake found a bundle of $100 bills in the alley outside his apartment When no one claimed the money, the cash (a total of $2,400) was returned to Blake Finally, Blake earned salary of $42,000 but almost $6,500 was withheld for income taxes and FICA tax Compute Blake's realized income and gross income $3,700 + $2,750 + $2,400 + $42,000 = $50,850 realized - $2,750 = $48,100 gross income Feedback: Realized income is $50,850 but gross income excludes municipal interest AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-01 Apply the concept of realization and explain when taxpayers recognize gross income Level of Difficulty: Easy Topic: Realization and recognition of income 107 Henry works part-time on auto repairs and restoration projects This year Henry was paid $5,400 for repairs he made to his neighbor's auto Henry's neighbor promised to pay Henry another $2,200 in cash next year Henry's brother borrowed $4,100 in cash in December of this year and gave him a negotiable promissory note for $4,300 due in three months with interest Henry sold the note in January for $3,500 Finally, Henry restored a car for the football coach The coach paid him with a pass to next year's football games The pass is worth $750 Compute Henry's gross income assuming that he uses the cash basis of accounting $5,400 + $750 = $6,150 Feedback: Gross income includes all income unless specifically excluded or deferred and cash basis taxpayers realize income when valuable property is received AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-01 Apply the concept of realization and explain when taxpayers recognize gross income Level of Difficulty: Medium Topic: Realization and recognition of income 5-221 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 108 Juan works as a landscaper for local businesses on weekends, and he often provides services in exchange for property This year Juan provided lawn-mowing services in exchange for $1,275 of car repair services, $3,570 of groceries, and a certificate of deposit (C.D.) for $4,050 The C.D matures next year with interest Finally, Juan received a gift card that can only be applied for $850 of clothing at a local mall Juan has only applied the gift card to purchase $100 of clothing Compute Juan's gross income assuming that he uses the cash basis of accounting $1,275 + $3,570 + $4,050 + $850 = $9,745 Feedback: Gross income includes all income unless specifically excluded or deferred and cash basis taxpayers realize income when valuable property is received AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-01 Apply the concept of realization and explain when taxpayers recognize gross income Level of Difficulty: Easy Topic: Realization and recognition of income 109 This year Kelsi received a $1,900 refund of state income taxes that she paid last year Last year Kelsi claimed itemized deductions of $7,200 including $2,800 of state income taxes How much of the refund, if any, must Kelsi include in gross income if the standard deduction last year was $6,100? $1,100 Feedback: The tax benefit is the lesser of the refund ($1,900) or the excess of the itemized deductions above the standard deduction ($7,200 - 6,100 = $1,100) Hence, Kelsi must include $1,100 of the $1,900 refund in gross income AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-01 Apply the concept of realization and explain when taxpayers recognize gross income Level of Difficulty: Hard Topic: Realization and recognition of income 5-222 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 110 In April of this year Victoria received a $1,400 refund of state income taxes that she paid last year Last year Victoria claimed itemized deductions of $8,690 Victoria's itemized deductions included state income taxes paid of $3,750 How much of the refund, if any, must Victoria include in gross income if the standard deduction last year was $6,100? $1,400 Feedback: The tax benefit is the lesser of the refund ($1,400) or the excess of the itemized deductions above the standard deduction ($8,690 - $6,100 = $2,590) Hence, Victoria must include the entire $1,400 refund in gross income AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-01 Apply the concept of realization and explain when taxpayers recognize gross income Level of Difficulty: Medium Topic: Realization and recognition of income 111 Aubrey and Justin divorced on June 30 of this year Through June 30 Aubrey earned $62,000 of salary, and Justin earned $45,000 For the year Aubrey reported a total salary of $130,000, and Justin earned a total salary of $88,000 Aubrey and Justin live in a community property state How much income earned will Justin report on his tax return for this year? $96,500 = [1/2 × ($62,000 + $45,000)] + ($88,000 - $45,000) = $53,500 + $43,000 Feedback: Under community property systems, the income earned from services by one spouse is treated as though it was earned equally by both spouses AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-01 Apply the concept of realization and explain when taxpayers recognize gross income Level of Difficulty: Medium Topic: Realization and recognition of income 5-223 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 112 Aubrey and Justin divorced on June 30 of this year Through June 30 Aubrey earned $62,000 of salary and Justin earned $45,000 For the year Aubrey reported a total salary of $130,000 and Justin earned a total salary of $88,000 Aubrey and Justin live in a community property state How much of the income will Aubrey report on her tax return for this year? $121,500 = [1/2 × ($62,000 + $45,000)] + ($130,000 - $62,000) = $53,500 + $68,000 Feedback: Under community property systems, the income earned from services by one spouse is treated as though it was earned equally by both spouses AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-01 Apply the concept of realization and explain when taxpayers recognize gross income Level of Difficulty: Medium Topic: Realization and recognition of income 113 Cyrus is a cash method taxpayer who reports on a calendar-year Last year Cyrus received salary of $88,000 and at year-end his employer announced that Cyrus would receive an additional year-end bonus of $10,000 in cash and a new TV worth $2,000 Cyrus didn't receive his bonus check until January of this year and the TV didn't arrive until March of this year Determine the amount Cyrus should include in his gross income for last year $88,000 Feedback: Under constructive receipt the bonus and the TV are not included in gross income until the year received AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-01 Apply the concept of realization and explain when taxpayers recognize gross income Level of Difficulty: Medium Topic: Realization and recognition of income 5-224 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 114 Kathryn is employed by Acme and they have been very pleased with her performance this year In December Kathryn was granted an extra week off with pay (pay for the week totaled $2,000) In addition, Kathryn was given tickets to a football bowl game worth $800 (Kathryn didn't use the tickets - she hates football) At year-end Kathryn was allowed to order new office furniture and Acme told her to take the old office furniture home The office furniture was originally purchased for $7,000, but it was fully depreciated and only worth about $1,000 Determine the amount Kathryn should include in her gross income $2,000 + $800 + $1,000 = $3,800 Feedback: Gross income includes the value of property received AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-01 Apply the concept of realization and explain when taxpayers recognize gross income Level of Difficulty: Medium Topic: Realization and recognition of income 115 Charles purchased an annuity from an insurance company that promised to pay him $20,000 per year for the next 12 years Charles paid $180,000 for the annuity How much of the first $20,000 payment should Charles include in gross income? $5,000 Feedback: A part of each payment represents a return of the original $180,000 investment and the remainder ($60,000) is income The original investment ($180,000) divided by the number of years indicates that $15,000 of each payment is a return of capital so the remaining $5,000 is income AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-02 Understand the distinctions between the various sources of income; including income from services and property Level of Difficulty: Easy Topic: Types of income 5-225 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 116 This year Larry received the first payment from an annuity that promises to pay him $3,000 per month for the rest of his life The IRS tables indicate that given Larry's age, he should expect to receive 310 monthly payments The cost of the annuity to Larry was $620,000 How much of the first $3,000 payment should Larry include in gross income? $3,000 - [$620,000/310] = $1,000 Feedback: A part of each payment represents a return of the original $620,000 investment The return of capital is prorated over the expected payment period so that each $3,000 monthly payment is composed of $2,000 of return of capital ($620,000/310 payments) and $1,000 of income AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-02 Understand the distinctions between the various sources of income; including income from services and property Level of Difficulty: Medium Topic: Types of income 117 Desai and Lucy divorced this year Lucy has custody of their child, Andrea, and under the divorce decree Desai pays Lucy $120,000 per year The payments must be made in cash and will cease if Lucy dies or remarries The payments drop to $100,000 per year once Andrea reaches the age of 18 How much of the payments should Lucy include in gross income this year? $100,000 Feedback: The constant payments qualify as "alimony" and should be included in Lucy's gross income The drop in payments is treated as child support because these payments cease upon the happening of a specific contingency related to the child AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-02 Understand the distinctions between the various sources of income; including income from services and property Level of Difficulty: Easy Topic: Types of income 5-226 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 118 Terri and Mike are seeking a divorce Terri and Mike own an art collection worth $357,000 that would belong to Terri Mike offered to make annual payments of cash to Terri each year for five years if Terry allows Mike to take possession of the art collection Mike insists however, that the annual payments must cease in the event of Terri's death What amount of annual payment must Terri demand to make her indifferent after taxes between taking possession of the ($357,000) art versus collecting the cash payments? Assume that Terri has a marginal tax rate of 15 percent and Mike's tax rate is 35 percent and ignore the time value of money $420,000 over years results in annual payments of $84,000 Feedback: The annual payments to Terri would be taxable alimony but the property division would be tax-free Terri wants to net $357,000 either nontaxable (property distribution) or after-tax (alimony) To determine the total cash payments ($X), we simply solve the following equation: $X (1 - 0.15 tax rate) = $357,000, which simplifies to X = $420,000 before-tax total payments If Mike pays $420,000 to Terri as alimony, he would save $147,000 ($420,000 × 35%) in taxes and thus, would only be paying $273,000 after taxes ($420,000 payments - $147,000 tax savings) for an art collection worth $357,000 AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-02 Understand the distinctions between the various sources of income; including income from services and property Level of Difficulty: Hard Topic: Types of income 119 J.Z (single taxpayer) is retired and received $10,000 of Social Security benefits this year How much of the $10,000 Social Security benefits is taxable if his only other income was $28,000 of pension income? $4,000 Feedback: J.Z.'s modified AGI + 50 percent of his Social Security benefits equals $28,000 + $5,000 (50% × $10,000) = $33,000 Thus, his taxable Social Security benefits are the lesser of (a) $5,000 (50 percent of his Social Security benefits) or (b) 50 percent of [$28,000 modified AGI + $5,000 (50% of Social Security benefits) - $25,000] = $4,000 Thus, his taxable Social Security benefits are $4,000 AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-02 Understand the distinctions between the various sources of income; including income from services and property Level of Difficulty: Medium Topic: Types of income 5-227 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 120 Wendell is an executive with CFO Tires At the beginning of this year the corporation loaned Wendell $50,000 at an interest rate of one percent Wendell would have paid interest of $2,500 this year if the interest rate on the loan had been set at the prevailing Federal interest rate Wendell used the funds as a down payment on a vacation home and during the year he paid $500 of interest to CFO On December 31, CFO forgave the loan and remaining interest What amount of gross income does Wendell recognize from the loan this year? $52,000 Feedback: Wendell must include $2,000 in gross income from the discounted interest rate he received on the loan ($2,500 interest at Federal rate minus $500 he actually was required to pay) Also, Wendell must include the $50,000 in gross income because the discharge of the debt is additional compensation AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Medium Topic: Exclusion provisions 121 Bobby and Sissy got married 2.5 years ago Since that time, they have lived in Bobby's home Sissy sold her previous home three years ago and excluded her entire gain ($80,000) at that time Bobby and Sissy decided to move to a bigger home this year As a result, they sold Bobby's home for $500,000 (original cost $150,000) How much of the gain from the sale is taxable? $0 Feedback: Because Bobby meets the ownership test, Bobby and Sissy meet the use test, and Sissy did not claim her exclusion within the previous two years, they may exclude the entire gain up to $500,000 AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Medium Topic: Exclusion provisions 5-228 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 122 Robert will be working overseas on a permanent assignment for an international company beginning on March of this year (306 days this year) His salary is $11,000 per month while Robert is overseas, but only $9,200 per month otherwise What is the minimum amount of Robert's salary that he must include in gross income this year? (Round your final answer to the nearest whole dollar amount & assume that there are 365 days in this year) $45,235 Feedback: The maximum foreign earned income exclusion for the year is $99,200 Robert will earn $18,400 during January and February and $110,000 during the remainder of the year Since he will be spending a total of more than 330 days abroad over a 12-month consecutive period, he is eligible to exclude foreign earned income However, he will be able to claim only a partial exclusion based upon his time abroad this year [$99,200 full exclusion × 306/365 (days in foreign country/days in year)] and thus he will report gross income of $45,235 ($128,400 83,165) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Hard Topic: Exclusion provisions 123 Simon was awarded a scholarship to attend State Law School from Gary Harris & Associates, Attorneys at Law The scholarship pays Simon's tuition ($7,000 per semester), fees ($500 per semester), and a $4,500 per semester stipend to pay for food and housing In order to qualify for the stipend, Simon must work 10 hours per week at Gary Harris & Associates during the term How much of the scholarship is Simon required to include in gross income? $12,000 per semester Feedback: The stipend is included in gross income because the terms of the scholarship require Simon to perform services AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Medium Topic: Exclusion provisions 5-229 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 124 This fall Angelina, age 35, plans to attend college To fund her tuition she cashed in Series EE savings bonds with a redemption value of $24,000 and an original cost of $16,800 Angelina plans on spending $7,200 of the proceeds to pay tuition The redemption proceeds are Angelina's only source of income What amount of interest must Angelina include in gross income this year? $5,040 Feedback: Angelina has realized interest of $7,200 but she is only eligible to exclude 30 percent of the interest income because she is only using 30 percent of the proceeds for a qualified purpose ($7,200/$24,000) Angelina is not required to phase-out the amount of the exclusion because her modified gross income is below the threshold for the phase-out of the exclusion AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Medium Topic: Exclusion provisions 125 Teresa was married on November of this year and on that day received numerous gifts from her extended family Her grandfather presented Teresa with a check for $15,000; her uncle gave Teresa 1,000 shares of Ford stock worth $10 per share (the uncle purchased the shares for $25 each); and her aunt presented Teresa with $50,000 of corporate bonds (Teresa received $1,500 of semiannual interest from the bonds on December 31 of this year) Finally, Teresa's parents paid off $50,000 of her student loans debt including $2,000 of accrued interest What amount, if any, must Teresa include in gross income this year? $500 (2 months of months interest received) Feedback: All of the gifts are excludible except for the interest that accrued on the corporate bonds after the date of the transfer AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Medium Topic: Exclusion provisions 5-230 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 126 Andres has received the following benefits this year Besides these benefits Andres missed work for two months due to an illness During his illness Andres received $6,500 in sick pay from a disability insurance policy Assume Andres has disability insurance provided by his employer as a nontaxable fringe benefit What amount, if any, must Andres include in gross income this year? $115,920 = $92,000 + $15,000 + $2,420 + $6,500 Feedback: The disability pay of $6,500 is included in gross income because the insurance premiums were paid as a nontaxable fringe benefit AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Medium Topic: Exclusion provisions 5-231 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 127 This year Joseph joined the board of directors Besides his director's fees, Joseph received the following employee benefits: The stock bonus consisted of 5,000 shares of Bell stock given to Joseph as compensation At the time of the transfer the stock was listed at $4 per share What amounts, if any, should Joseph include in gross income this year? $239,000 = $204,000 + $20,000 + $15,000 Feedback: Joseph would report the value of the stock ($20,000) as compensation AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Easy Topic: Exclusion provisions 128 Caroline is retired and receives income from a number of sources The interest payments are from bonds that Caroline purchased over past years and a disability insurance policy that Caroline purchased after her retirement Calculate Caroline's gross income $12,350 = $5,400 + $2,300 + $1,900 + $2,750 Feedback: Caroline is not taxed on the disability payments because she purchased the insurance In addition, Caroline's gross income is clearly below the Social Security phase-in threshold, so the Social Security benefits are also excluded AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking 5-232 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Easy Topic: Exclusion provisions 129 Alex is 63 years old and retired This year Alex won $212,200 in the state lottery Alex also received $20,000 from an annuity he purchased eight years ago He purchased the annuity, to be paid annually for 15 years, for $157,500 Alex received $10,000 in Social Security benefits for the year Calculate Alex's gross income $230,200 = $212,200 + $9,500 + $8,500 Feedback: The annuity return of capital is ($157,500/15) = $10,500; thus, the taxable portion is $9,500 Given Alex's income, his Social Security benefits are 85 percent taxable (i.e., $10,000 × 85 percent) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Medium Topic: Exclusion provisions 130 Vincent is a writer and U.S citizen After being out of work for the st half of the year, Vincent moved permanently to Ireland on July He worked for an Irish magazine and earned $110,000 in salary from July 4th - December 31st Earlier in April of this year Vincent received a $1,500 refund of the $3,600 in state income taxes his previous employer withheld from his pay last year Vincent claimed $6,900 in itemized deductions last year (the standard deduction for a single filer was 6,100) Vincent wants to elect to use the foreign-earned income exclusion to the extent he is eligible Calculate Vincent's gross income for this year (Round your final answer to the nearest whole dollar amount and assume there are 365 days in the year.) $61,608 = $110,000 - $49,192 + $800 Feedback: $99,200 × 181/365 = $49,192 maximum exclusion The tax benefit is the lesser of the refund ($1,500) or the excess of the itemized deductions above the standard deduction ($6,900 - $6,100 = $800) Hence, Vincent must include $800 of the $1,500 refund in gross income AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Hard Topic: Exclusion provisions 5-233 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 131 Lisa and Collin are married Lisa works as an engineer and earns a salary of $116,000 Collin works at a beauty salon and reported wages of $45,000 Lisa received $500 of interest from corporate bonds and $250 of interest from a municipal bond Lisa acquired these bonds prior to her marriage to Collin Collin's father passed away on April 14 He inherited cash of $50,000 and his baseball card collection, valued at $2,000 As beneficiary of his father's life insurance policy, Collin also received $150,000 The couple spent a weekend in Atlantic City in November and came home with gambling winnings of $1,200 Collin was injured in an accident at the salon He was unable to work for a month, but during this time he received $5,000 from disability insurance he purchased several years ago Collin also received $2,000 in workman's compensation, and $1,500 from the salon for the emotional trauma he suffered from the accident Calculate Lisa and Collin's gross income for this year assuming they will file married joint $162,700 = $116,000 + $45,000 + $500 + $1,200 Feedback: The municipal interest, inheritance and life insurance, disability pay, workman's compensation, and damages are all excluded from gross income AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 05-03 Apply basic income exclusion provisions to compute gross income Level of Difficulty: Hard Topic: Exclusion provisions 5-234 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education ... deductions exceeded the standard deduction by $2 $200 is included because itemized deductions exceeded the standard deductio $200 is included even if Mary claimed the standard deduction None of. .. B C D E Joyce recognizes $1,500 of taxable interest income Joyce's employer recognizes $1,500 of deductible interest expense Joyce recognizes $1,500 of imputed compensation income Joyce recognizes... that Caroline purchased over past years and a disability insurance policy that Caroline purchased after her retirement Calculate Caroline's gross income 5-28 Copyright © 2015 McGraw-Hill Education