tax test 2
LO.2 What is the taxpayer's gross income in each of the following situations? Clint collected $50,000 as the beneficiary of a group term life insurance policy when his wife died. The premiums on the policy were paid by his deceased wife's employer.
Zero. Life insurance proceeds paid to the beneficiary upon death of the insured are excluded from gross income
LO.3 Myrna and Geoffrey filed a joint tax return in 2017. Their AGI was $85,000, and itemized deductions were $13,700, which included $4,000 in state income tax. In 2018, they received a $1,800 refund of the state income taxes they paid in 2017. The standard deduction for married filing jointly in 2017 was $12,700. Under the tax benefit rule, what amount of the state income tax refund is included in gross income in 2018?
Because the standard deduction in 2017 was $12,700, the $4,000 of state income taxes the taxpayers paid in 2017 yielded a tax benefit of only $1,000 ($13,700 itemized deductions − $12,700 standard deduction) in 2017. Under the tax benefit rule, only $1,000 of the state income tax refund is included in gross income in 2018.
LO.2Andrea entered into a § 529 qualified tuition program for the benefit of her daughter, Joanna. Andrea contributed $15,000 to the fund. The fund balance had accumulated to $25,000 by the time Joanna was ready to enter college. However, Joanna received a scholarship that paid for her tuition, fees, books, supplies, and room and board. Therefore, Andrea withdrew the funds from the § 529 plan and bought Joanna a new car. Assume instead that Joanna's scholarship did not cover her room and board, which cost $7,500 per academic year. During the current year, $7,500 of the fund balance was used to pay for Joanna's room and board. The remaining amount was left in the § 529 plan to cover her room and board for future academic years. What are the tax consequences to Andrea and to Joanna of using the $7,500 to pay for the room and board?
Both Andrea and Joanna can exclude the $7,500 from their gross income because this amount was used to pay for higher education expenses.
Ch. 6 problem 34
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Chapter 6, Problem 44
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Chapter 6, Problem 45
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Chapter 6, problem 48
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Chapter 6, problem 55
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Chapter 7, Problem 21
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Chapter 7, Problem 22
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Chapter 7, Problem 27
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Chapter 7, Problem 33
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Chapter 7, Problem 37
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LO.1 Discuss when a bad debt deduction can be taken for a nonbusiness debt.
A loss is deductible only in the year of total worthlessness for a nonbusiness bad debt and is classified as a short-term capital loss
LO.2 Albert established a qualified tuition program for each of his twins, Kim and Jim. He started each fund with $20,000 when the children were five years old. Albert made no further contributions to his children's plans. Thirteen years later, both children have graduated from high school. Kim's fund has accumulated to $45,000, while Jim's has accumulated to $42,000. Kim decides to attend a state university, which will cost $60,000 for four years (tuition, fees, room and board, and books). Jim decides to go to work instead of going to college. During the current year, $7,500 is used from Kim's plan to pay the cost of her first semester in college. Because Jim is not going to college now or in the future, Albert withdraws the $42,000 plan balance and gives it to Jim to start his new life after high school. What are the tax consequences to Albert and Jim of Jim's qualified tuition program being closed?
Albert's basis in the account is $20,000. So he must include $22,000 ($42,000 − $20,000) in his gross income. He is also subject to a 10% additional tax of $2,200, reported on Form 5329.
Last year Aleshia identified $15,000 as a nonbusiness bad debt. In that tax year, before considering the tax implications of the nonbusiness bad debt, Aleshia had $100,000 of taxable income, of which $12,000 consisted of short-term capital gains. This year Aleshia collected $8,000 of the amount she had previously identified as a bad debt. Determine Aleshia's tax treatment of the $8,000 received in the current tax year.
Aleshia must include the $8,000 in gross income of the current tax year, but only to the extent of the tax benefit in the previous year. Because Aleshia had capital gains of $12,000 in the previous year, all of the $15,000 bad debt would have been deducted last year ($12,000 offsetting the capital gains and $3,000 as a net capital loss deduction). As a result, Aleshia would have to include all of the $8,000 received in gross income in the current year.
LO.2 Albert established a qualified tuition program for each of his twins, Kim and Jim. He started each fund with $20,000 when the children were five years old. Albert made no further contributions to his children's plans. Thirteen years later, both children have graduated from high school. Kim's fund has accumulated to $45,000, while Jim's has accumulated to $42,000. Kim decides to attend a state university, which will cost $60,000 for four years (tuition, fees, room and board, and books). Jim decides to go to work instead of going to college. During the current year, $7,500 is used from Kim's plan to pay the cost of her first semester in college. Because Jim is not going to college now or in the future, Albert withdraws the $42,000 plan balance and gives it to Jim to start his new life after high school. During the period since the plans were established, should Albert or the twins have been including the annual plan earnings in gross income? Explain.
All of the plan earnings during this period are excluded from gross income because the expectation is that the entire amount in the accounts will be used for higher education expenses.
LO.1 Explain how an account receivable can give rise to a bad debt deduction.
An account receivable can give rise to a bad debt deduction if income arising from the creation of the account receivable was previously included in gross income.
LO.2Andrea entered into a § 529 qualified tuition program for the benefit of her daughter, Joanna. Andrea contributed $15,000 to the fund. The fund balance had accumulated to $25,000 by the time Joanna was ready to enter college. However, Joanna received a scholarship that paid for her tuition, fees, books, supplies, and room and board. Therefore, Andrea withdrew the funds from the § 529 plan and bought Joanna a new car. What are the tax consequences to Andrea of withdrawing the funds?
Andrea must include $10,000 ($25,000 − $15,000) in her gross income (i.e., the fund earnings). She will also be subject to a 10% penalty.
LO.2 What is the "actually paid" requirement for the deduction of an expense by a cash basis taxpayer? Does actual payment ensure a deduction? Explain.
Cash basis taxpayers can deduct an expense only when it has been paid with cash or other property. Borrowing the money to pay the expense (or charging it on a bank credit card) constitutes actual payment. However, actual payment does not ensure a current deduction. For example, capital expenditures must be capitalized. Subsequently, the expenditure may be amortized, depleted, or depreciated. Except in certain circumstances, prepaid items currently cannot be deducted.
LO.1 Classify each of the following expenditures paid in 2018 as a deduction for AGI, a deduction from AGI, or not deductible: Mia pays alimony to Bill.
Deduction for AGI provided the separation agreement was signed prior to 2019. Alimony payments related to separation agreements signed after 2018 are not deductible.
LO.1 Classify each of the following expenditures paid in 2018 as a deduction for AGI, a deduction from AGI, or not deductible: Bonita pays expenses associated with her rental property.
Deduction for AGI.
LO.1 Classify each of the following expenditures paid in 2018 as a deduction for AGI, a deduction from AGI, or not deductible: Rex, who is self-employed, contributes to his pension plan.
Deduction for AGI.
LO.1 Classify each of the following expenditures paid in 2018 as a deduction for AGI, a deduction from AGI, or not deductible: Sandra gives cash to her church.
Deduction from AGI
LO.1 Classify each of the following expenditures paid in 2018 as a deduction for AGI, a deduction from AGI, or not deductible: Albert pays Dr. Dafashy for medical services rendered.
Deduction from AGI (subject to 7.5% floor).
LO.2 Aubry, a cash basis and calendar year taxpayer, decides to reduce his taxable income for 2018 by buying $65,000 worth of supplies for his business on December 27, 2018. The supplies will be used up in 2019. Would your answer in part (a) change if Aubry bought the supplies because the seller was going out of business and offered a large discount on the price? Explain.
If Aubry bought the supplies at a discount, he would be motivated by business reasons other than tax reduction. Because the supplies would be used within the following year, the Zaninovich case indicates that Aubry could deduct the supplies.
LO.3Dolly is a cash basis taxpayer. In 2018, she filed her 2017 South Carolina income tax return and received a $2,200 refund. Dolly took the standard deduction on her 2017 Federal income tax return, but will itemize her deductions in 2018. Molly, a cash basis taxpayer, also filed her 2017 South Carolina income tax return in 2018 and received a $600 refund. Molly had $12,000 in itemized deductions on her 2017 Federal income tax return, but will take the standard deduction in 2018. How does the tax benefit rule apply to Dolly's and Molly's situations? Explain.
Dolly is not required to recognize income from the receipt of the state income tax refund of $2,200. The refund merely corrects for her overpayment, and the original payment did not affect her taxable income. On the other hand, Molly received a tax benefit in the form of a deduction on he 2017 Federal income tax return. Therefore, the $600 refund is the recovery of a tax benefit. Whether Dolly and Molly itemize deductions in the year of recovery (2018) is not relevant to whether they realized gross income from the recovery of 2017 state income taxes.
In January 2018, Ezra purchased 2,000 shares of Gold Utility Mutual Fund for $20,000. In June, Ezra received an additional 100 shares as a dividend, in lieu of receiving $1,000 in cash dividends. In December, the company declared a two-for-one stock split. Ezra received an additional 2,100 shares, but there was no option to receive cash. At the time of the stock dividend in December and at the end of the year, the fund shares were trading for $5 per share. Also, at the end of the year, the fund offered to buy outstanding shares for $4.50. Ezra did not sell any shares during the year. What is Ezra's gross income from the 100 shares received in June?
Ezra must include $1,000 in gross income, the amount of cash he could have received.
LO.2 In January 2018, Ezra purchased 2,000 shares of Gold Utility Mutual Fund for $20,000. In June, Ezra received an additional 100 shares as a dividend, in lieu of receiving $1,000 in cash dividends. In December, the company declared a two-for-one stock split. Ezra received an additional 2,100 shares, but there was no option to receive cash. At the time of the stock dividend in December and at the end of the year, the fund shares were trading for $5 per share. Also, at the end of the year, the fund offered to buy outstanding shares for $4.50. Ezra did not sell any shares during the year. Should Ezra be required to recognize gross income in 2018 even though the fair market value of his investment at the end of the year was less than the fair market value at the beginning of the year? Explain.
Ezra must recognize the income he realized in 2018 of $1,000. He is not permitted to deduct an economic loss until realization occurs; that is, when he sells the shares.
LO.4 Discuss at what point in time a theft loss generally is recognized.
Generally, a theft loss is deducted in the year of discovery. However, no theft loss is permitted if a reimbursement claim with a reasonable prospect of full recovery exists. If the taxpayer has a partial claim of recovery, only part of the loss can be claimed in the year of discovery, and the remainder is deducted in the year the claim is settled.
LO.3 Terry traveled to a neighboring state to investigate the purchase of two hardware stores. His expenses included travel, legal, accounting, and miscellaneous expenses. The total was $52,000. He incurred the expenses in June and July 2018. Under the following circumstances, what can Terry deduct in 2018? Terry was in the hardware store business and acquired the two hardware stores and began operating them on October 1, 2018.
He could deduct $52,000.
LO.3 Terry traveled to a neighboring state to investigate the purchase of two hardware stores. His expenses included travel, legal, accounting, and miscellaneous expenses. The total was $52,000. He incurred the expenses in June and July 2018. Under the following circumstances, what can Terry deduct in 2018? Terry was in the hardware store business and did not acquire the two hardware stores.
He could deduct $52,000.
LO.2Holly was injured while working in a factory and received $12,000 as workers' compensation while she was unable to work because of the injury. Jill, who was self-employed, was also injured and unable to work. Jill collected $12,000 on an insurance policy she had purchased to replace her loss of income while she was unable to work. How much are Holly and Jill each required to include in their gross income?
Holly can exclude the $12,000 of workers' compensation benefits she received from her gross income. Jill can exclude the $12,000 she received for lost income because it was received from an insurance policy that she had purchased.
Rosa's employer has instituted a flexible benefits program. Rosa will use the plan to pay for her daughter's dental expenses and other medical expenses that are not covered by health insurance. Rosa is in the 24% marginal tax bracket and estimates that the medical and dental expenses not covered by health insurance will be within the range of $4,000 to $5,000. Her employer's plan permits her to set aside as much as $5,000 in the flexible benefits account. Rosa does not itemize her deductions. Rosa puts $5,000 into her flexible benefits account, and her actual expenses are only $4,000. What is her cost of overestimating her expenses?
If Rosa overfunds the account by $1,000, the cost of the error is $760 [(1 − .24) × $1,000].
Rosa's employer has instituted a flexible benefits program. Rosa will use the plan to pay for her daughter's dental expenses and other medical expenses that are not covered by health insurance. Rosa is in the 24% marginal tax bracket and estimates that the medical and dental expenses not covered by health insurance will be within the range of $4,000 to $5,000. Her employer's plan permits her to set aside as much as $5,000 in the flexible benefits account. Rosa does not itemize her deductions. Rosa puts $4,000 into her flexible benefits account, and her actual expenses are $5,000. What is her cost of underestimating the expenses?
If Rosa underfunds the account by $1,000, the cost of the error is her marginal tax rate times the underfunded amount, or $240 (.24 × $1,000).
LO.2 Aubry, a cash basis and calendar year taxpayer, decides to reduce his taxable income for 2018 by buying $65,000 worth of supplies for his business on December 27, 2018. The supplies will be used up in 2019. Can Aubry deduct the expenditure for 2018? Explain.
It is doubtful that Aubry can deduct the $65,000 of supplies in 2018 because he was motivated by tax considerations (i.e., to manipulate income).
Jarrod receives a scholarship of $18,500 from Riggers University to be used to pursue a bachelor's degree. He spends $12,000 on tuition, $1,500 on books and supplies, $4,000 for room and board, and $1,000 for personal expenses. How much may Jarrod exclude from his gross income?
Jarrod may exclude $13,500 ($12,000 tuition + $1,500 books and supplies) from his gross income. The $4,000 spent for room and board and $1,000 spent for personal expenses are includible in Jarrod's gross income.
Ellie purchases an insurance policy on her life and names her brother, Jason, as the beneficiary. Ellie pays $32,000 in premiums for the policy during her life. When she dies, Jason collects the insurance proceeds of $500,000. As a result, how much gross income does Jason report?
Life insurance proceeds paid to the beneficiary because of the death of the insured are exempt from income tax. Congress chose to exempt life insurance proceeds for the following reasons: • For family members, life insurance proceeds serve much the same purpose as a nontaxable inheritance. • In a business context (as well as in a family situation), life insurance proceeds replace an economic loss suffered by the beneficiary. The $500,000 Jason receives is exempt from Federal income tax.
LO.2 Maud, a calendar year taxpayer, is the owner of a sole proprietorship that uses the cash method. On February 1, 2018, she leases an office building to use in her business for $120,000 for an 18-month period. To obtain this favorable lease rate, she pays the $120,000 at the inception of the lease. How much rent expense may Maud deduct on her 2018 tax return?
Maud can deduct $120,000 in 2018 for the rent for February 2018 through July 2019. She does qualify under the one-year rule for prepaid expenses because the period for which prepayments have been made does not extend past December 31, 2019
LO.3 Lavinia incurs various legal fees in obtaining a divorce. Which types of expenses associated with the divorce are deductible by Lavinia, and which are not?
Most legal expenses related to a divorce are of a personal nature and are not deductible. Before 2018, legal expenses related to tax advice were deductible as miscellaneous itemized deductions subject to a 2%-of-AGI floor. From 2018 through 2025, miscellaneous itemized deductions are not deductible. If legal expenses for a divorce are related to a trade or business activity (Schedule C) or a rental activity (Schedule E), they are deductible if they are ordinary and necessary expenditures.
LO.2 Albert established a qualified tuition program for each of his twins, Kim and Jim. He started each fund with $20,000 when the children were five years old. Albert made no further contributions to his children's plans. Thirteen years later, both children have graduated from high school. Kim's fund has accumulated to $45,000, while Jim's has accumulated to $42,000. Kim decides to attend a state university, which will cost $60,000 for four years (tuition, fees, room and board, and books). Jim decides to go to work instead of going to college. During the current year, $7,500 is used from Kim's plan to pay the cost of her first semester in college. Because Jim is not going to college now or in the future, Albert withdraws the $42,000 plan balance and gives it to Jim to start his new life after high school. What are the tax consequences to Kim and Albert of the $7,500 being used for the first semester's higher education costs?
Neither Albert nor Kim report gross income associated with the $7,500 because it is used for qualified higher education expenses.
LO.2 Albert established a qualified tuition program for each of his twins, Kim and Jim. He started each fund with $20,000 when the children were five years old. Albert made no further contributions to his children's plans. Thirteen years later, both children have graduated from high school. Kim's fund has accumulated to $45,000, while Jim's has accumulated to $42,000. Kim decides to attend a state university, which will cost $60,000 for four years (tuition, fees, room and board, and books). Jim decides to go to work instead of going to college. During the current year, $7,500 is used from Kim's plan to pay the cost of her first semester in college. Because Jim is not going to college now or in the future, Albert withdraws the $42,000 plan balance and gives it to Jim to start his new life after high school. Because of her participation in the qualified tuition program, Kim received a 10% reduction in tuition charges; so less than $7,500 was withdrawn from her account. Is either Albert or Kim required to include the value of this discount in gross income? Explain.
Neither Albert nor Kim will be required to include the 10% discount in gross income.
LO.3 Gordon anticipates that being positively perceived by the individual who is elected mayor will be beneficial for his business. Therefore, he contributes to the campaigns of both the Democratic and the Republican candidates. The Republican candidate is elected mayor. Can Gordon deduct any of the political contributions he made?
No, a deduction is not permitted for political contributions.
Billy fell off a bar stool and hurt his back. As a result, he was unable to work for three months. He sued the bar owner and collected $100,000 for the physical injury and $50,000 for the loss of income. Billy also collected $15,000 from an income replacement insurance policy he purchased. Amber was away from work for three months following heart bypass surgery. Amber collected $30,000 under an income replacement insurance policy purchased by her employer. Are the amounts received by Billy and Amber treated the same under the tax law? Explain.
No. Billy's award of $150,000 can be excluded from gross income because it arose out of a physical personal injury, even though $50,000 was to replace income he would have earned and would have been subject to tax. The $15,000 he received from the income replacement policy he purchased is excluded from Billy's gross income as a recovery of his cost of the policy (but is not taxable even though the total benefit received may exceed the premiums paid). Amber is taxed on the $30,000 she received under the income replacement insurance policy because the premiums were paid by her employer (and would not have been included in her gross income).
Wes was a major league baseball pitcher who earned $10 million for his 20 wins this year. Sam was also a major league baseball pitcher before a career-ending injury caused by a negligent driver. Sam sued the driver and collected $6 million as compensation for lost estimated future income as a pitcher and $4 million as punitive damages. Do the amounts that Wes and Sam receive have the same effect on their gross income? Explain.
No. The $10 million amount that Wes received is included in his gross income. However, Sam is required to include only the $4 million in punitive damages in his gross income. His compensatory damages are excluded from his gross income, even though the amount replaces a loss of income, because the amount was received as a result of physical personal injury.
LO.3 Terry traveled to a neighboring state to investigate the purchase of two hardware stores. His expenses included travel, legal, accounting, and miscellaneous expenses. The total was $52,000. He incurred the expenses in June and July 2018. Under the following circumstances, what can Terry deduct in 2018? Terry did not acquire the two hardware stores and was not in the hardware store business.
None of Terry's expenses are deductible.
LO.1 Classify each of the following expenditures paid in 2018 as a deduction for AGI, a deduction from AGI, or not deductible: Lu, who operates a sole proprietorship, takes a client to dinner to discuss new business.
Not deductible.
LO.1 Classify each of the following expenditures paid in 2018 as a deduction for AGI, a deduction from AGI, or not deductible: Roberto gives cash to his father as a birthday gift.
Not deductible.
Fynn incurred and paid the following expenses during 2018: $50 for a ticket for running a red light while he was commuting to work. $100 for a ticket for parking in a handicapped parking space. $200 to an attorney to represent him in traffic court as to the two tickets. $500 to an attorney to draft an agreement with a tenant for a one-year lease on an apartment that Fynn owns. $1,000 to an attorney to negotiate a reduction in his child support payments. $2,500 to an attorney to negotiate a reduction in his qualified alimony payments to a former spouse. Calculate the amount of Fynn deductible expenses.
Only the $500 paid to the attorney to draft the lease is deductible by Fynn. This expense is an ordinary and necessary expense incurred in connection with rental property held for the production of income. The tickets and the related legal expenses are not deductible because they are personal in nature. Even if related to the conduct of a trade or business or the production of income, they are disallowed as a deduction because they violate public policy. The $1,000 payment for negotiating a reduction in child support payments is personal in nature. The $2,500 paid related to the alimony payment is a miscellaneous itemized deduction, so it is not deductible from 2018 through 2025.
Rosa's employer has instituted a flexible benefits program. Rosa will use the plan to pay for her daughter's dental expenses and other medical expenses that are not covered by health insurance. Rosa is in the 24% marginal tax bracket and estimates that the medical and dental expenses not covered by health insurance will be within the range of $4,000 to $5,000. Her employer's plan permits her to set aside as much as $5,000 in the flexible benefits account. Rosa does not itemize her deductions. Does your answer in part (c) suggest that Rosa should fund the account closer to the low end or to the high end of her estimates?
Rosa should fund the flexible benefit account using an amount closer to the low end than the high end of the estimate
Rosa's employer has instituted a flexible benefits program. Rosa will use the plan to pay for her daughter's dental expenses and other medical expenses that are not covered by health insurance. Rosa is in the 24% marginal tax bracket and estimates that the medical and dental expenses not covered by health insurance will be within the range of $4,000 to $5,000. Her employer's plan permits her to set aside as much as $5,000 in the flexible benefits account. Rosa does not itemize her deductions. What is Rosa's cost of underfunding as compared with the cost of overfunding the flexible benefits account?
The cost of underfunding is a .24 error, and the cost of overfunding is a .76 × (1 − .24) error; that is, the underfunding error costs only 32% (.24/.76) of the cost of overfunding.
LO.1 Suzanne, a single taxpayer, operates a printing business as a sole proprietor. The business has two employees who are paid a total of $90,000 during 2018. Assume that the business has no significant assets. During 2018, the business generates $150,000 of income, and Suzanne's taxable income before the QBI deduction is $155,000. What is Suzanne's qualified business income deduction?
Suzanne's QBI deduction is $30,000 ($150,000 × 20%). The W-2 wages and qualified property limitation does not apply because Suzanne's taxable income before the QBI deduction is less than $157,500.
LO.1 Suzanne, a single taxpayer, operates a printing business as a sole proprietor. The business has two employees who are paid a total of $90,000 during 2018. Assume that the business has no significant assets. During 2018, the business generates $150,000 of income, and Suzanne's taxable income before the QBI deduction is $155,000. What is Suzanne's qualified business income deduction if the facts are the same except the business income is $250,000 and Suzanne's taxable income before the QBI deduction is $270,000?
Suzanne's taxable income before the QBI deduction exceeds $207,500. As a result, the W2 wages and qualified property limitation must be included. As a result, Suzanne's QBI deduction is $45,000, the lower of: $50,000 (20% × $250,000), or $45,000 (50% × W-2 wages of $90,000).
LO.3 Terry traveled to a neighboring state to investigate the purchase of two hardware stores. His expenses included travel, legal, accounting, and miscellaneous expenses. The total was $52,000. He incurred the expenses in June and July 2018. Under the following circumstances, what can Terry deduct in 2018? Terry acquired the two hardware stores but was not in the hardware store business when he acquired them. Operations began on October 1, 2018.
Terry can immediately expense $3,000 and amortize the $49,000 balance ($52,000 − $3,000) over a period of 180 months beginning in October (the month the business is started). The deduction for 2018 is $3,817 [$3,000 + $817 ($49,000 ÷ 180 × 3 months)].
LO.2 What is the taxpayer's gross income in each of the following situations? Megan received $10,000 from her employer to help her pay medical expenses not covered by insurance.
The $10,000 as compensation, unless this is paid under a nondiscriminatory medical reimbursement plan available to other employees.
LO.2 What is the taxpayer's gross income in each of the following situations? Blake received $15,000 from his deceased wife's employer "to help him in his time of greatest need."
The $15,000 is an excluded gift because it was paid based on Blake's need.
Sally was an all-state soccer player during her junior and senior years in high school. She accepted an athletic scholarship from State University. The scholarship provided the following: Tuition and fees $15,000 Housing and meals 6,000 Books and supplies 1,500 Transportation 1,200 Determine the effect of the scholarship on Sally's gross income.
The $16,500 received for tuition, fees, books, and supplies can be excluded from Sally's gross income as a scholarship. The $6,000 received for room and board and the $1,200 received for transportation must be included in her gross income. The athletic scholarship is considered a payment to further the recipient's education and is not compensation for services. `
Sally was an all-state soccer player during her junior and senior years in high school. She accepted an athletic scholarship from State University. The scholarship provided the following: Tuition and fees $15,000 Housing and meals 6,000 Books and supplies 1,500 Transportation 1,200 Sally's brother, Willy, was not a gifted athlete, but he received $8,000 from their father's employer as a scholarship during the year. The employer grants the children of all executives a scholarship equal to one-half of annual tuition, fees, books, and supplies. Willy also received a $6,000 scholarship (to be used for tuition) as the winner of an essay contest related to bioengineering, his intended field of study. Determine the effect of the scholarships on Willy's and his father's gross income.
The $8,000 "scholarship" is additional compensation to Willy's father. The fact that the "scholarships" are awarded only to the children of executives indicates that the employer is not simply making payments to assist the student seeking his or her education, but rather to compensate an employee. However, the $6,000 scholarship received as a contest winner is excluded from gross income. Although contest winnings are generally subject to tax, the exception is when the prize is a scholarship.
LO.2, 5Wilbur has been offered a job at a salary that would put him in the 24% marginal tax bracket. In addition to his salary, he would receive health insurance coverage. Another potential employer does not offer health insurance but has agreed to match the first offer on an after-tax and insurance basis. The cost of health insurance comparable to that provided by the other potential employer is $9,000 per year. How much more in salary must the second potential employer pay so that Wilbur's financial status will be the same under both offers?
The additional before-tax salary that is required to purchase the health insurance for $9,000, when the marginal tax rate is 24%, is $11,842 [$9,000/(1 − .24)]. This assumes that Wilbur will not be able to deduct the insurance as a medical expense because of the adjusted gross income floor and/or the standard deduction.
LO.2Ted works for Azure Motors, an automobile dealership. All employees can buy a car at the company's cost plus 2%. The company does not charge employees the $300 dealer preparation fee that nonemployees must pay. Ted purchased an automobile for $29,580 ($29,000 + $580). The company's cost was $29,000. The price for a nonemployee would have been $33,900 ($33,600 + $300 preparation fee). What is Ted's gross income from the purchase of the automobile?
The discount on the price of the automobile of $4,600 ($33,600 − $29,000) is a qualified employee discount. The discount can be excluded from Ted's gross income because the price he paid was above the employer's cost. However, Ted must include in gross income 80% of the dealer preparation fee, a service, of $300, which is $240 ($300 × 80%). The maximum qualified employee discount that can be excluded for a service is 20%.
LO.6 Discuss the rationale behind the excess business loss provision.
The purpose of the excess business loss limitation is to limit the amount of nonbusiness income (e.g., salaries, interest, dividends, and capital gains) that can be "sheltered" from tax as a result of business losses.
LO.2 In January 2018, Ezra purchased 2,000 shares of Gold Utility Mutual Fund for $20,000. In June, Ezra received an additional 100 shares as a dividend, in lieu of receiving $1,000 in cash dividends. In December, the company declared a two-for-one stock split. Ezra received an additional 2,100 shares, but there was no option to receive cash. At the time of the stock dividend in December and at the end of the year, the fund shares were trading for $5 per share. Also, at the end of the year, the fund offered to buy outstanding shares for $4.50. Ezra did not sell any shares during the year. What is Ezra's gross income from the receipt of the 2,100 shares as a two-for-one stock split in December?
The stock dividend is nontaxable because he did not have the option of receiving cash.
Leland pays premiums of $5,000 for an insurance policy in the face amount of $25,000 upon the life of Caleb and subsequently transfers the policy to Tyler for $7,500. Over the years, Tyler pays subsequent premiums of $1,500 on the policy. Upon Caleb's death, Tyler receives the proceeds of $25,000. As a result, what amount is Tyler required to include in his gross income?
There are exceptions to the general rule that life insurance proceeds paid to the beneficiary because of the death of the insured are exempt from income tax. A life insurance policy (other than one associated with accelerated death benefits) may be transferred after it is issued by the insurance company. If the policy is transferred for valuable consideration, the insurance proceeds are includible in the gross income of the transferee to the extent the proceeds received exceed the amount paid for the policy by the transferee plus any subsequent premiums paid. Therefore, Tyler must include $16,000 [$25,000 proceeds − ($7,500 paid for policy + $1,500 in subsequent premiums)] in his gross income.
Tobias has a brokerage account and buys on the margin, which resulted in an interest expense of $20,000 during the year. Income generated through the brokerage account was as follows: Municipal interest $ 50,000 Taxable dividends and interest 350,000 How much investment interest can Tobias deduct?
Tobias can deduct only the interest expense attributable to taxable income. The interest attributable to the municipal interest income is not deductible. Thus, only $17,500 ($350,000/$400,000 × $20,000) is deductible.
LO.1 "All income must be reported, and all deductions are allowed unless specifically disallowed in the Code." Discuss.
While the Code provides an all-inclusive definition of income, deductions must be specifically provided for in the Code in order to be permitted.
LO.2What is the difference between a cafeteria plan and an employee flexible spending plan?
With a cafeteria plan, the employee receives a salary and is provided by the employer with a fixed amount that he or she can allocate among a range of possible nontaxable fringe benefits and taxable benefits. With a flexible spending plan, a portion of the employee's salary is set aside for specific uses that would have been excludible from gross income had the employer paid these expenses. The employee's gross income is reduced by the amount that goes into the flexible spending account, and the withdrawals are excluded from gross income. However, any unused funds are forfeited by the employee
What is the taxpayer's gross income in each of the following situations? Darrin received a salary of $50,000 in 2018 from his employer, Green Construction.
a. $50,000 salary.
LO.2 What is the taxpayer's gross income in each of the following situations? In July 2018, Green gave Darrin an all-expense-paid trip to Las Vegas (value of $3,000) for exceeding his sales quota.
b. $3,000, the value of the trip.
