Chapter 5 - Gross Income and Exclusions

True or False 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

True or False A portion of each payment received from a purchased annuity contract represents income.

True

True or False A taxpayer generally includes in gross income the amount of debt forgiven by a lender.

True

True or False 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

True or False Constructive receipt represents the principle that cash-basis taxpayers will be taxed on income when it is made available to them without substantial restrictions.

True

True or False Excluded income will never be subject to the federal income tax.

True

True or False 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

True or False Interest earned on a city of Denver bond is excluded from gross income (for federal tax purposes).

True

True or False Interest income is taxed in the year in which it is received by the taxpayer or credited to the bank account.

True

True or False 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

True or False 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 if he did not deduct state income taxes last year.

True

True or False Qualified fringe benefits received by an employee can be excluded from gross income.

True

True or False Realized income is included in gross income unless a tax provision specifies that it can be deferred or excluded.

True

True or False Scholarships are excluded from gross income for degree candidates even if the scholarship pays for required fees and books in addition to tuition.

True

True or False The all-inclusive definition of income means that gross income is defined very broadly.

True

True or False The receipt of prizes and awards is generally taxable.

True

True or False U.S. citizens generally are subject to tax on all income whether it is generated in the United States or in foreign countries.

True

True or False When a carpenter provides $100 of services in exchange for $100 of groceries, the carpenter has realized $100 of income.

True

True or False When an asset is sold, the taxpayer calculates the gain or loss on the sale of the asset by subtracting the tax basis of the asset from the proceeds of the sale.

True

True or False Workers' compensation benefits are excluded from gross income.

True

True or False An employee may exclude up to a 40 percent employer-provided discount on services received by the employee.

False

True or False Barter clubs are an effective means of avoiding realization for tax purposes.

False

True or False Gambling winnings are included in gross income only to the extent that the winnings exceed gambling losses incurred during the same period.

False

True or False Recognized income may be in the form of cash or property received (but not services received).

False

True or False 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.

False

True or False The assignment of income doctrine requires that in order to shift income from the property producing the income to another person, the taxpayer must transfer only the income to the other person.

False

True or False The exclusion ratio for a purchased annuity is the cost of the annuity divided by the interest rate.

False

True or False The tax law defines alimony to include transfers of property (but not cash) between former spouses.

False

True or False 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.

False

True or False Unemployment benefits are excluded from gross income.

False

True or 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.

False

True or False A taxpayer who borrows money will include that amount borrowed in their gross income under the all-inclusive definition of income.

False - Debt does not generate economic benefit.

True or False Gross income includes all income realized during the year.

False - Deferred and excluded income is not included in gross income.

True or False Regardless of when a divorce agreement is executed, alimony is included in gross income of the recipient and is deductible for AGI by the payer.

False - For any divorce or separation agreement executed after December 31, 2018, alimony payments are not included in the gross income of the person receiving the payments and are not deductible by the person paying the alimony.

True or False 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.

False - Gross income only includes the net of sales proceeds less related selling expenses and tax basis in the asset sold.

This year, Barney and Betty sold their home (sales price $750,000; cost $200,000). All closing costs were paid by the buyer. Barney and Betty owned and lived in their home for 18 months. Assuming no unusual or hardship circumstances apply, how much of the gain is included in gross income? a. $550,000 b. $300,000 c. $250,000 d. $50,000 e. None of the choices are correct.

a. $550,000 All of the gain is included in gross income because Barney and Betty do not meet the two-year ownership and use tests.

Rhett made his annual gambling trip to Uwin Casino. On this trip Rhett won $250 at the slots and $1,200 at poker. Also this year, Rhett made several trips to the racetrack, but he lost $700 on his various wagers. What amount must Rhett include in his gross income? a. $1,450 b. $1,200 c. $750 d. $250 e. $0—gambling winnings are not included in gross income

a. $1,450 Taxpayers must include the gross amount of their gambling winnings for the year in gross income.

Deb has found it very difficult to repay her loans. Because of these difficulties, the bank decided to forgive one of her most recent loans, an amount of $45,000. After the loan was discharged, Deb had total assets of $232,000 and her remaining loans totaled $217,000. What amount must Deb include in her gross income? a. $15,000 b. $45,000 c. $30,000 d. $28,000 e. $0—Deb was not solvent when the loan was discharged

a. $15,000 A discharge of indebtedness is not taxable if the taxpayer is insolvent before and after the debt forgiveness. If the discharge of indebtedness makes the taxpayer solvent, the taxpayer recognizes taxable income to the extent of his or her solvency.

Pam recently was sickened by eating spoiled peanut butter. She successfully sued the manufacturer for her medical bills ($3,700), her emotional distress ($6,000—she now fears peanut butter), and punitive damages ($44,000). What amount must Pam include in her gross income? a. $44,000 b. $50,000 c. $47,700 d. $9,700 e. $0—none of these benefits are included in gross income

a. $44,000 The tax laws specify that any payments (other than punitive damages) on account of a physical injury or physical sickness are nontaxable. Damages taxpayers receive for emotional distress associated with a physical injury are also excludable. Punitive damages are fully taxable, however, because they are intended to punish the harm-doer rather than to compensate the taxpayer for injuries.

Frank received the following benefits from his employer this year. What amount must Frank include in his gross income? Salary - 54,450 Health Insurance - 2,900 Group-term Life Insurance - 1,800 a. $54,450 b. $57,350 c. $56,250 d. $59,150 e. $0—these benefits are excluded from gross income.

a. $54,450 An employee may exclude from income the cost of medical and dental health insurance premiums and group-term life insurance (face $50,000) premiums an employer pays on the employee's behalf.

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. Wilma must include the $1,000 of interest in her income this year. b. Wilma must include the $1,000 of interest in her income when she cashes the CD. c. Wilma must include the $1,000 of interest in her income this year only if the bank waives the early withdrawal penalty. d. Wilma must include the $1,000 of interest in her income next year if she does not pay the early withdrawal penalty. e. All of the choices are correct.

a. Wilma must include the $1,000 of interest in her income this year. Interest is taxed when credited to the account.

Gross income includes: a. all income from whatever source derived unless excluded by law b. excluded income c. deferred income d. all realized income e. all of these choices are correct

a. all income from whatever source derived unless excluded by law Income can be paid in cash, property, or services.

This year Zach was injured in an auto accident. As a result, he received the following payments. Zach received $18,000 of disability pay. Zach has disability insurance provided by his employer as a nontaxable fringe benefit. Zach's employer paid $4,300 in disability premiums for Zach this year. Zach's hospital bills totaled $4,500 and were paid by his health insurance. Zach has health insurance provided by his employer as a nontaxable fringe benefit. Zach's employer paid $6,250 in health insurance premiums for Zach this year. What amount must Zach include in his gross income? a. $22,500 b. $18,000 c. $4,500 d. $10,550 e. $0—none of these benefits are included in gross income

b. $18,000 Any payment a taxpayer receives from a health and accident insurance policy for medical or dental expenses paid by the taxpayer is excluded from the taxpayer's income. If the employer pays the disability premiums for an employee as a nontaxable fringe benefit, the employee must include all disability benefits in gross income.

This year Ed celebrated his 25th year as an employee of Designer Jeans Company. In recognition of his long and loyal service, the company awarded Ed a gold watch worth $250 and a $2,000 cash bonus. What amount must Ed include in his gross income? a. $2,250 b. $2,000 c. $250 d. $0 if Ed offers to contribute his watch and bonus to a qualified charity e. $0—all employee awards are excluded from gross income

b. $2,000 Cash bonus payments are includible in gross income but awards of tangible property to employees for length of service or safety achievement are excluded up to $400 of value.

Barney and Betty got divorced in 2018. In the divorce decree Betty agreed to pay Barney $24,000 per year for five years (or until Barney's death or remarriage) and $10,000 per year until their daughter, Pebbles, turns 19 years old. What amount (if any) is included in Barney's gross income in 2019? a. 10,000 b. 24,000 c. 34,000 d. 39,000 e. None of the payments are included in gross income

b. 24,000 Alimony payments are in cash pursuant to a divorce and do not survive the death of the recipient.

Which of the following is a true statement about the first payment received from a purchased annuity? a. The payment is included in gross income. b. A portion of the payment is a return of capital. c. The payment can only be taxed in the year after the annuity was purchased. d. The payment is not taxed until the annuity payments cease altogether. e. None of these are true statements.

b. A portion of the payment is a return of capital. A portion of the first payment from a purchased annuity will be a return of capital depending upon the amount paid for the investment and the expected number of payments to be received.

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. Harold will continue to apply the annuity exclusion ratio to determine the amount of each annuity payment includible in gross income. b. Harold will include the entire amount of each annuity payment in gross income after he recovers the cost of the annuity. c. The entire amount of each annuity payment is excluded from gross income after Harold recovers his cost of the annuity. d. Harold must request that the IRS calculate his exclusion ratio based upon a revised life expectancy. e. All of these choices are correct.

b. Harold will include the entire amount of each annuity payment in gross income after he recovers the cost of the annuity. The entire annuity payment is included in gross income once the cost of the annuity is recovered.

Which of the following is not a necessary condition for income to be included in gross income? a. income must be realized b. income must be paid in cash c. income cannot be excluded by law d. income must be made available to a taxpayer on the cash basis e. all of these choices are correct.

b. income must be paid in cash Gross income includes the value of property received in exchange for services.

Graham has accepted an offer to do graduate work in the chemistry department at State University. The chemistry department offered Graham a $5,000 tuition reduction and $3,500 toward the cost of room and meals. Under the terms of the scholarship Graham must work in the chemistry labs during the summer as a research assistant. What amount must Graham include in his gross income? a. $8,500 b. $5,000 c. $3,500 d. $2,500 e. $0—none of these benefits are included in gross income

c. $3,500 The scholarship exclusion applies to the tuition reduction but not the cost of room and board.

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. $80 b. $72 c. $48 d. $32 e. None of the choices are correct.

c. $48 The annuity exclusion ratio is ($3,200/100) = $32 return of capital per payment. Hence, $48 of the $80 is included in gross income.

Charles and Camilla got divorced in 2018. Under the terms of the decree Charles pays Camilla $50,000 in cash in each of the next five years (or until Camilla's death or remarriage). In addition, Charles transferred a castle worth $2,000,000 to Camilla in 2018 and will pay $12,000 per year to support their son, Clyde, until he turns 19 years old. What amount (if any) is included in Camilla's gross income in 2019? a. 2,062,000 b. 12,000 c. 50,000 d. 2,050,000 e. None of the payments are included in gross income

c. 50,000 Property settlements and child support are not included in gross income, but alimony payments (cash) are includible.

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 rendered. Which of the following is a true statement? a. Hillary is taxed on the $5,000 of service income in the year she cashes the check. b. Hillary is taxed on the $5,000 of service income in the year the check was mailed. c. Hillary is taxed on the $5,000 of service income in the year she receives the check. d. Hillary is taxed on the $5,000 of service income in the year she provides the services. e. None of the choices are correct.

c. Hillary is taxed on the $5,000 of service income in the year she receives the check. Under constructive receipt Hillary is taxed on income when property is received or made available to her.

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. Sally need not recognize any gross income unless she sells the football tickets. b. Sally's exchange does not result in taxable income. c. Sally is taxed on the value of the football tickets even if she cannot attend the game. d. Sally is taxed on the value of her sewing services only if she is a professional seamstress. e. None of the choices are correct.

c. Sally is taxed on the value of the football tickets even if she cannot attend the game. No realization occurs until the stock is sold or becomes worthless.

Which of the following describes how the annuity exclusion ratio is calculated for an annuity paid over a fixed period? a. The expected return is divided by the number of payments. b. The original investment is divided by the prevailing interest rate. c. The original investment is divided by the number of payments. d. The expected return is divided by the prevailing interest rate. e. None of the choices are correct.

c. The original investment is divided by the number of payments. This is the definition of annuity exclusion ratio.

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. $200 is included because Mary itemized her deductions last year. b. $200 is included if itemized deductions exceeded the standard deduction by $200. c. $200 is included because itemized deductions exceeded the standard deduction. d. $200 is included even if Mary claimed the standard deduction. e. None of the choices are correct - refunds of state income taxes are not included in gross income.

d. $200 is included even if Mary claimed the standard deduction. Refund amounts are included in gross income only to the extent that the original deduction provided a tax benefit. The $4,000 of deduction produced a tax benefit of $200 if itemized deductions exceeded the standard deduction by $200.

Karl works at Moe's grocery. This year Karl was paid $43,000 in salary, but he was allowed to purchase his groceries at 10 percent below Moe's cost. This year Karl spent $3,600 to purchase groceries, costing Moe $4,000. The groceries were worth $6,000. What amount must Karl include in his gross income? a. $46,600 b. $47,000 c. $49,000 d. $43,400 e. $45,500

d. $43,400 Employees must recognize imputed income to the extent they are allowed to purchase goods from their employer at a price below the employer's cost. [$43,000 + ($4,000 × 0.10)] = $43,400.

This year, Fred and Wilma, married filing jointly, sold their home (sales price $750,000; cost $200,000). All closing costs were paid by the buyer. Fred and Wilma owned and lived in their home for 20 years. How much of the gain is included in gross income? a. $550,000 b. $300,000 c. $250,000 d. $50,000 e. None of the choices are correct.

d. $50,000 Fred and Wilma may exclude $500,000 of their $550,000 gain ($750,000 sales price − $200,000 cost = $550,000 gain) because they meet the ownership and use tests. Thus, they only include $50,000 of the gain in their gross income.

Shaun is a student who has received an academic scholarship to State University. The scholarship paid $14,000 for tuition, $2,500 for fees, and $1,000 for books. In addition, Shaun's dormitory fees of $8,500 were paid by the university when he agreed to counsel freshman on campus living. What amount must Shaun include in his gross income? a. $9,500 b. $11,000 c. $2,500 d. $8,500 e. $0—none of these benefits are included in gross income.

d. $8,500 College students seeking a degree are allowed to exclude from gross income scholarships that pay for tuition, fees, books, supplies, and other equipment required for the student's courses. Any excess scholarship amounts (such as for room or meals) are fully taxable. The scholarship exclusion applies only if the recipient is not required to perform services in exchange for receiving the scholarship.

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. 2,050 b. 350 c. 180 d. 170 e. None of these - refunds of state income taxes are not included in gross income

d. 170 Refund amounts are included in gross income only to the extent that the original deduction provided a tax benefit. The $2,400 of deduction produced a tax benefit of $350, so the entire $170 is included in income.

To calculate a gain or loss on the sale of an asset, the proceeds from the sale are reduced by which of the following? a. Tax basis of the property b. Selling expenses c. Amount realized d. Tax basis of the property and selling expenses e. All of these choices are correct

d. Tax basis of the property and selling expenses Tax basis and selling expenses reduce proceeds for a "casual" sale of property.

Irene's husband passed away this year. After his death, Irene received $250,000 of proceeds from life insurance on her husband, and she inherited her husband's stock portfolio, worth $750,000. What amount must Irene include in her gross income? a. $1 million. b. $750,000. c. $500,000. d. $0, but only if Irene does not opt to receive the life insurance proceeds in a lump sum. e. $0—none of these benefits are included in gross income.

e. $0—none of these benefits are included in gross income. Taxpayers exclude inheritances and life insurance proceeds from gross income.

Which of the following statements about alimony payments is true for divorce agreements executed before 2019? a. To qualify as alimony, payments must be made in cash. b. Alimony payments are includible in the gross income of the recipient. c. To qualify as alimony, payments cannot continue after the death of the recipient. d. To qualify as alimony, payments must be made under a written agreement or divorce decree that does not designate the payments as "nonalimony" or child support. e. All of the choices are correct.

e. All of the choices are correct.

In January of the current year, Dora made a gift of stock to her granddaughter. At the time of the gift, the stock was worth $15,000. Several months later in the same year after the gift, a $500 dividend was declared on the stock and paid to Dora's granddaughter. What amount must Dora's granddaughter include in her gross income for the current year? a. $2,000 b. $15,000 c. $15,500 d. $2,500 e. None of the choices are correct.

e. None of the choices are correct. The gift of the stock is excluded but the dividend on the shares is taxable. Hence, the answer is $500.

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. 10,000 b. 9,000 c. 1,000 d. Barney can deduct $10,000 only if he includes $1,000 in his taxable income. e. None of these choices are correct - Barney is not entitled to a loss deduction

e. None of these choices are correct - Barney is not entitled to a loss deduction No realization occurs until the stock is sold or becomes worthless.