Chapter 5 - Gross Income and Exclusions

Allison won $3,200 betting on a long-shot in the Kentucky Derby. Unfortunately, she lost her lucky streak and ended up losing $5,000 on her next (and last) trip to the racetrack. Allison heard that she will be able to deduct her gambling losses, so she is feeling a little better. Assuming that Allison is not a professional gambler and does not itemize deductions, how much of the $5,000 loss will she be able to deduct?

$0 Reason: Because Allison does not itemize, she will not be able to deduct any of the losses.

Chester incurred $14,500 in hospital and medical bills during the current year. His health insurance policy reimbursed him $11,600 toward those expenses. What amount should be included in Chester's gross income?

$ 0

Bobby received a $3,500 scholarship for the semester. He used $3,000 to pay tuition to the community college, and the remaining $500 was paid toward textbooks. How much of the scholarship must be included in gross income?

$0

Life insurance proceeds may be included in gross income when ______. (Check all that apply.)

- proceeds are paid over time and a portion represents taxable interest payments - a life insurance policy is transferred to another party for valuable consideration

Common income exclusion provisions relate to ______. (Check all that apply.)

- the gain on the sale of a personal residence - fringe benefits - municipal bond interest

The highest percentage of Social Security benefits that may be taxed is __________%, and only for moderate to high-income taxpayers.

Blank 1: 85 or eight five

For all divorce agreements executed after December 31, 2018, __________ payments are excluded from gross income of the recipient and __________ (deductible/nondeductible) for the spouse making the payment.

Blank 1: alimony Blank 2: nondeductible, non deductible, or non-deductible

In general, when a taxpayer cashes out a life insurance policy before death, taxable income may result. However, if the taxpayer is __________ ill, the portion of the proceeds used for long-term care is excluded from gross income. If the taxpayer is __________ ill, the proceeds are NOT taxable.

Blank 1: chronically Blank 2: terminally

Rather than claiming the foreign-earned income exclusion, taxpayers may claim a foreign tax __________ or a foreign tax __________ for income taxes paid to other countries. (Enter only one word per blank.)

Blank 1: deduction or deductions Blank 2: credit or credits

Earnings on investments in plans such as 529 plans, Coverdell savings accounts, and U.S. Series EE bonds are excluded from taxation if the proceeds are used for qualifying __________ expenses.

Blank 1: education, educational, school, higher education, or higher-education

In addition to receiving a salary from a company, many employers provide __________ __________ that are excluded from gross income. (Enter only one word per blank.)

Blank 1: fringe Blank 2: benefits or benefit

When an individual transfers property to another taxpayer during their life, without receiving or expecting to receive value in return, the property transferred is a(n) __________ and is __________ (taxable/nontaxable) to the person receiving the property.

Blank 1: gift or gifts Blank 2: nontaxable, non taxable, or non-taxable

For below-market-loans, the discounted interest rate is treated as interest __________ to the lender and interest __________ to the borrower.

Blank 1: income or revenue Blank 2: expense

Interest on __________ bonds is excluded from federal income taxation. (Enter only one word per blank.)

Blank 1: municipal, local, city, state, or muni

Income from __________ takes different forms, such as dividends, interest, rents, royalties, and annuities.

Blank 1: property, investments, properties, or investment

Under the cash method, taxpayers recognize income in the period they __________ it, rather than when they actually __________ it.

Blank 1: receive, get, received, collect, collected, obtain, or obtained Blank 2: earn or earned

True or false: Income and deductions generated within a partnership or S corporation that are subject to various tax treatments (i.e. qualified dividends, capital gains, etc.) retain their character when they flow-through to the owners rather than being reclassified as ordinary income or loss.

True Reason: Certain types of income and deductions will retain their character and be treated as Congress intended on the owners' individual tax returns.

Which one of the following types of income is NOT unearned revenue generated from owning property?

Earnings from services rendered

True or false: In general, prizes awarded to taxpayers are excluded from gross income.

False Reason: Prizes and awards are taxable unless they meet very specific exceptions.

Which of the following tax-advantaged accounts can be used to fund qualified educational expenses from kindergarten through 12th grade and higher education expenses such as tuition, books, fees, supplies, and reasonable room and board.

Section 529 Plans

Which of the following options is NOT available to taxpayers who have worked outside the United States and meet the requirements necessary to receive tax relief on their foreign earnings?

Tax deduction for foreign-earned income

Which one of the following is NOT an advantage of the cash method for reporting income?

Taxpayers are able to deduct expenses in the period incurred, which may be before they actually pay them.

True or false: Income and deductions from a partnership or S corporation are taxed on the owners' tax returns rather than the entity tax return.

True Reason: Partnership and S corporation entities are "flow through" entities. The income and deductions flow through to the owners.

Which of the following statements is INCORRECT regarding workers' compensation payments?

The payments are included in gross income because they are a replacement of wages.

True or false: Punitive damages are generally fully taxable to the recipient.

True Reason: Punitive damages are taxable because their purpose is to punish the harm-doer rather than compensate the taxpayer.

What is the tax treatment for a taxpayer receiving a gold watch valued at $350 in recognition of his 25th year of working for the same company?

The value of the watch is excluded from gross income.

Which of the following terms is used to refer to income from property?

Unearned income

Which of the following items is income from services?

Wage income

The term used when one former spouse is required to provide financial support to the other spouse pursuant to a legal separation or divorce is __________.

alimony

An investment that pays a stream of equal payments over time is a(n) __________.

annuity

The taxpayer who earns income from services must recognize the income, and the income from property is taxed to the person who owns the property under the __________ __________ __________ doctrine.

assignment of income

Income received as a result of services provided by the taxpayer, including business income, is referred to as __________ (earned/unearned) income.

earned

For non-government employees working outside the United States, there is a foreign-earned income ______ available if certain residency requirements are met.

exclusion

Taxpayers receiving indirect economic benefits, such as bargain purchases or below-market loans, are said to have __________ income which may be taxable. (Enter only one word per blank.)

imputed

In general, when a taxpayer's debt is discharged by a lender, the taxpayer's gross income will __________ (include / exclude) the amount forgiven.

include

For a divorce agreement entered into BEFORE January 1, 2019, alimony is ______

included in the gross income of the person receiving it and deductible by the person paying it

An inheritance ______.

may be subject to the federal estate tax which is paid by the estate of the person who died

Any reimbursement a taxpayer receives from a medical or accident insurance policy for medical expenses paid by the taxpayer during the current year are __________ (taxable/nontaxable) for the taxpayer.

nontaxable

In general, life insurance proceeds are __________ (taxable/nontaxable) to the beneficiary of the policy.

nontaxable

In personal injury cases, any damages awarded due to __________ injury are exempt from taxation. (Enter only one word per blank.)

physical

The ______ principle for determining when income is generated provides taxpayers with an objective measure for valuing the transaction and with the wherewithal to pay the taxes when cash is involved.

realization

Up to 85% of __________ __________ benefits, in retirement, may be taxable for taxpayers with moderate to high taxable income.

social security

Court-ordered cash payments pursuant to a divorce or legal separation which provide financial support to an ex-spouse and do not continue after the death of the ex-spouse are referred to as ______.

alimony

Which of the following fringe benefits provided by an employer is NOT excluded from gross income?

Group life insurance coverage in excess of $50,000

Which of the following transactions results in realized income during the current year?

Huey receives a set of new tires valued at $400 for his car in exchange for cleaning and painting the mechanic's garage.

Which of the following choices does NOT describe an annuity?

It is a lump sum payment that is usually received by the beneficiary of a life insurance policy.

Bart sold a parcel of land for $21,000. He paid a real estate agent a commission of $1,500 for assisting with the sale. Bart had purchased the land several years earlier for $20,000. What is the amount realized on the sale of the land?

$19,500 Reason: Amount realized = Sales proceeds minus selling expenses

During the current year, Sam received interest income from the following investments: $400 from State of Wyoming bonds, $200 from Ford Motor Co., $50 from City of Laramie bonds, $100 from U.S. Treasury bonds. How much of the interest received will be included in gross income?

$300 Reason: $300 - The State of Wyoming and City of Laramie bonds are not taxable.

Sam traded a parcel of land for a tractor and a car. He had purchased the land five years earlier for $16,000. The market value of the car and tractor is $20,000. What is the amount of gross income resulting from this transaction?

$4,000 Reason: The gross income is the fair market value received ($20,000) less the basis in the property given ($16,000) which equals $4,000.

Sandy earned a salary of $50,000 last year. Her parents gave her a car valued at $23,000 for her birthday. In addition, she earned $1,200 in interest income on a savings account and inherited $75,000 from her grandmother's estate. What is the amount of Sandy's gross income for the year?

$51,200 Reason: The salary and interest are the only amounts included in gross income.

Andrea owed $12,000 on a medical bill to University Hospital. The hospital agreed to discharge the debt due to Andrea's financial situation. Immediately prior to the discharge of the debt, Andrea's debts exceeded her assets by $5,000. How much of the debt forgiveness will Andrea need to include in her gross income?

$7,000 Reason: By forgiving $12,000 in debt, Andrea will be solvent by $7,000, so she should include $7,000 in gross income.

Andrew earned $5,000 in wages while working a part-time job during the current year. He also received a scholarship for $12,000. He used $9,000 for tuition and $800 for books. The remaining $2,200 went to help cover the cost of housing. During the summer, Andrew's uncle died and Andrew inherited $30,000. What is the amount of Andrew's gross income for the current year?

$7,200

Chad has received the following income and benefits during the current year: $65,000 salary, $4,800 employer-provided health insurance, $1,500 municipal bond interest, $2,000 dividend income, $500 from a partnership, and a $10,000 judgment for lost wages due to an age discrimination lawsuit. What amounts should Chad include in his gross income? (Check all that apply.)

- $2,000 dividend income - $10,000 judgment - $500 partnership income - $65,000 salary

Which of the following represents economic benefits to a taxpayer? (Check all that apply.)

- Cash received for completing a job - Interest income on investments - A computer received in exchange for services rendered

Certain types of investment earnings are nontaxable if the proceeds are used to pay for qualifying educational expenditures including ______. (Check all that apply.)

- Coverdell savings accounts - Section 529 plans - U.S. Series EE bonds

Which of the following statements are correct? (Check all that apply.)

- If a taxpayer receives a state tax refund for a tax year where she deducted the state tax paid, she must report the refund as gross income. - When taxpayers sell non-depreciable assets, they may exclude the original cost of those assets from gross income. - Taxpayers who exchange or trade goods or services with each other must recognize the increase in value of the goods or services as income.

What are the advantages of the realization principle for defining gross income? (Check all that apply.)

- It provides the taxpayer with the wherewithal to pay when cash is received in the transaction. - It provides an objective measure of the value of the transaction.

Choose the items that are excluded from gross income. (Check all that apply.)

- Municipal bond interest - Qualified fringe benefits

Which of the following payments to a taxpayer should be included in gross income? (Check all that apply.)

- Punitive damages awarded after an accident at work where the taxpayer sustained a non-physical injury - Emotional distress damages awarded due to slander of the taxpayer's reputation - Compensatory damages for lost wages awarded in a sex discrimination lawsuit

Which of the following statements are INCORRECT regarding the receipt of Social Security benefits? (Check all that apply.)

- Social Security benefits are not taxable because the contributions were taxed when the taxpayer was working. - 50% of Social Security benefits are taxable to all taxpayers because the employer contributed funds that were never taxed to the employee.

Which of the following choices are characteristics of qualified tuition programs, also known as 529 plans? (Check all that apply.)

- The distributions can be made for tuition expenses for kindergarten through 12th grade. - Distributions made to the beneficiary for purposes other than education are taxable and incur a penalty on the plan earnings. - Earnings on the account are NOT taxable if used for qualified education expenses.

Which of the following choices are characteristics of Coverdell Educational Savings Accounts? (Check all that apply.)

- The maximum yearly contributions to the account are limited to $2,000 for each beneficiary. - Earnings on the account are NOT taxable if used for qualified educational expenses. - Distributions may be used to pay for qualified educational costs of kindergarten through 12th grade. - Reasonable room and board costs are included in qualified higher education expenses.

In order to exclude the maximum amount of foreign-earned income from U.S. taxation, which of the following conditions must be met? (Check all that apply.)

- The taxpayer must have his or her tax home in a foreign country. - The taxpayer must be considered a resident of or have resided in the foreign country for 330 days in a consecutive 12-month period.

Which of the following choices describe exclusions and deferrals for tax purposes? (Choose all that apply.)

- These provisions are the result of specific congressional action. - These provisions are narrowly defined. - These provisions are often granted in order to subsidize or encourage particular behaviors.

Which of the following situations will result in an award being excluded from gross income? (Check all that apply.)

- When the award is given for scientific, literary, or charitable achievement and meets certain other requirements - When the award is a noncash item valued at less than $400, and given for either safety or years of service by an employee

Which of the following statements are CORRECT when describing "Workers' Compensation?" (Choose all that apply.)

- Workers' compensation benefits are not taxable to the recipient because the payments result from a physical injury. - Workers' compensation benefits are paid to employees who have been injured in a work-related situation.

Jerry receives an annuity payment of $2,500 per month. Jerry purchased the 20-year annuity for $250,000. What is the amount of the annuity that represents a return of capital and is, therefore, nontaxable?

41.67% or $12,500 per year Reason: $250,000 ÷ (20 × $2,500 × 12 mos.) = 41.67%

Janice started receiving an annuity payment of $1,500 per month when she turned 68 years old. She purchased the annuity for $225,000 and will continue to draw the monthly payment for the remainder of her life. What is the amount of the annuity that represents a return of capital each year and is, therefore, nontaxable? (Round your calculation of the return of capital percentage to the nearest whole number.)

71% or $12,780 per year Reason: $225,000 ÷ (17.6 × $1,500 × 12 mos.) = 71%

Mitchell and Midge are married and file a joint return. Mitchell receives $9,600 in Social Security each year. Their modified AGI is $48,000. $__________ of the Social Security benefits is subject to taxation.

Blank 1: 8160 or 8,160

Daniels, Edwards, and Findley are equal partners in DEF Industries. The company generated net income of $180,000 during the year and distributed $20,000 cash each of the partners. Edwards will report $__________ in taxable income from the partnership.

Blank 1: 60,000 or 60000

Which of the following represent "earned income"?

Bill received $800 over the summer doing lawn care services for his neighbors.

Jamarcus injured his hand playing softball which prevented him from being able to work. He had purchased a disability policy for himself earlier in the year. and received $1,300 in disability benefits while he was away from work. Jamarcus should include $__________ in gross income.

Blank 1: 0 or zero

Jamarcus injured his hand playing softball which prevented him from being able to work. His employer provides disability insurance as a nontaxable fringe benefit to all employees. Jamarcus received $1,300 in disability benefits while he was away from work. Jamarcus should include $__________ in gross income.

Blank 1: 1300 or 1,300

Single taxpayers meeting certain home ownership and use requirements can permanently exclude up to $__________ of the realized gain on the sale of their principal residence. (Enter your answer as a whole number.)

Blank 1: 250000 or 250,000

Arnie is single and receives Social Security benefits. His modified AGI is $27,000 and his Social Security benefits are $7,200 per year. $__________ of his Social Security benefits are taxable.

Blank 1: 2800 or 2,800

Which one of the following choices states that income is realized if a taxpayer receives income and there are no restrictions on the taxpayer's use of the income?

Claim of right doctrine

Which one of the following types of taxable income is NOT considered to be service income?

Dividend income

Action Sport is an S corporation owned equally by three shareholders. During the current year, Action Sport generated taxable income of $60,000. What is the tax treatment, if any, of the $60,000 income?

Each shareholder will report $20,000 in taxable income.

True or false: Scholarships received by college students qualify as gifts and are, therefore, nontaxable. The actual use of the money (tuition, fees, housing, meals, and any other expenses) does not affect the taxable status of the scholarship.

False Reason: Scholarships that pay for tuition, fees, books, supplies, and other equipment required by the student's courses are excluded from the gross income. Housing is taxable.

True or false: Darlene owns stock in several different companies. When she received a dividend check from her Avatar stock, she endorsed the checks and deposited the money in her daughter's checking account. Consequently, her daughter will be assessed the tax on the dividends.

False Reason: The assignment of income doctrine states that the owner of income-producing property must pay tax on the income from the property.

True or false: Taxpayers who do not meet the resident requirement or live in a foreign country for at least 330 consecutive days in a 12 month period are NOT eligible to receive ANY of the foreign-earned income exclusion on otherwise eligible income.

False Reason: The exclusion is computed on a daily basis, so the maximum exclusion is reduced pro rata for each day during the calendar year that the taxpayer is not considered a resident or does not actually live in the foreign country. Therefore, a taxpayer may still receive some level of the foreign-earned income exclusion.

Which of the following types of cash receipts is NOT taxable to the recipient?

Gift from a friend

Which of the following statements is INCORRECT regarding gross income?

Income is only included in gross income when spelled out in specific tax provisions.

Janice and Jarrod are married and live in a community property state. Janice is NOT employed outside the home, and Jarrod earns a salary of $98,000. During the year, they earned $2,000 on investments that are owned jointly. The investments were made after they were married, with money earned by Jarrod. How is the gross income treated for federal income tax purposes?

Janice is deemed to have earned $50,000 and Jarrod is deemed to have earned $50,000. Reason: Since Janice and Jarrod live in a community property state, their income is split evenly between the two of them.

Bart sold a parcel of land for $21,000. He paid a real estate agent a commission of $1,500 for assisting with the sale. Bart had purchased the land several years earlier for $20,000. What is the gain or loss on the sale of the land?

Loss of $500 Reason: $21,000 - $1,500 - $20,000 = ($500)

Which one of the following choices does NOT represent an economic benefit to the taxpayer?

Proceeds from a loan

What are the tax consequences for a taxpayer who is receiving a life annuity and who has already lived longer than his or her life expectancy?

The entire amount of each additional payment of the annuity is taxable.

What are the tax consequences for a taxpayer who dies before recovering his investment in an annuity contract?

The amount of the unrecovered investment is deducted on the taxpayer's final income tax return.

Which of the following statements is INCORRECT regarding gambling winnings and losses for recreational gamblers?

The excess of gambling winnings over gambling losses are included in gross income.

How are the proceeds from a life insurance policy treated if the policy is cashed in early for its surrender value when there is no chronic or terminal illness present?

The excess of the cash surrender value over the premiums paid is included in the taxpayer's gross income.

When is a discharge of indebtedness NOT included in gross income?

When the taxpayer is insolvent before and after the debt forgiveness

The __________ __________ __________ doctrine states that income has been realized if a taxpayer receives income and there are no restrictions on the taxpayer's use of the income.

claim of right

The income earned from services by one spouse is treated as though it was earned equally by both spouses in a(n) __________ __________ system. (Enter only one word per blank.)

community property

When income has been credited to the taxpayer's account or when the income is unconditionally available to the taxpayer, the taxpayer is aware of the availability and there are no restrictions on the income, __________ __________ is deemed to have occurred. (Enter only one word per blank.)

constructive receipt

If a taxpayer cashes out a life insurance policy before death due to a chronic illness, she may exclude from income the amount used to pay for her __________ - __________ __________.

long term care

To satisfy the ownership test for excluding the gain on a personal residence the taxpayer must have owned the residence for ______.

two or more years during the past five-year period ending on the date of sale

Income from property is referred to as (earned/unearned) __________ income.

unearned