Chapter 15 Tax
A sole proprietor in the 37% tax bracket pays her 16-year-old son a reasonable salary of $14,000 for services performed for the proprietorship. Compute the family's tax savings if the son has no other income and takes a $12,000 standard deduction. A) $4,980 B) $5,180 C) $4,440 D) None of the above
A) $4,980 Explanation: $5,180 tax savings from deduction ($14,000 × 37%) - $200 tax on child's $2,000 taxable income ($14,000 - $12,000).
Mrs. Lee, age 70, withdrew $10,000 from her Roth IRA this year. Mrs. Lee opened this account in 2000. The balance in the account at year-end was $76,600, which included $50,000 of contributions. Compute the taxable portion of the $10,000 withdrawal. A) $0 B) $4,226 C) $5,774 D) $10,000
A) $0
Six years ago, HOPCO granted Lin Sing an incentive stock option (ISO) to purchase 1,000 shares of HOPCO stock for $55 per share. On date of grant, the market price was $50 per share. This year, Lin Sing exercised the ISO when the market price was $64 per share. How much ordinary income does she recognize because of the exercise? A) $0 B) $5,000 C) $9,000 D) $14,000
A) $0
Ms. Jorland is a 30-year-old single taxpayer. Her $3,760 AGI is the total of $7,940 interest and dividend income from a trust fund, $4,190 income from a rent property, and an $8,370 loss from a new business that she started this year. Compute Ms. Jorland's maximum IRA contribution. A) $0 B) $3,760 C) $4,190 D) $5,500
A) $0 Explanation: Ms. Jorland has no compensation or self-employment income.
In 2018, Amanda earned $70,000 self-employment income. She was allowed a $4,945 above-the line deduction for her SE tax. Compute Amanda's maximum contribution to her profit-sharing Keogh plan. A) $13,011 B) $12,022 C) $65,055 D) $55,000
A) $13,011 Explanation: ($70,000 − SE tax deduction) × 20%.
Six years ago, Linus Corporation granted Pauline an incentive stock option (ISO) to purchase 5,000 shares of Linus stock for $13 per share. On date of grant, the market price was $11 per share. Last year, Pauline exercised the ISO when the market price was $47 per share. This year, she sold the stock for $40 per share. Compute Pauline's gain or loss recognized on sale. A) $135,000 gain B) $10,000 loss C) $35,000 loss D) No gain or loss on sale
A) $135,000 gain Explanation: $200,000 amount realized on sale − $65,000 cost basis.
An employee receives $110,000 of group term life insurance coverage per year. The cost of this coverage to his employer is $90. The cost based on the IRS's uniform premium table is $1.08 per year per $1,000 of coverage. What amount is taxable to the employee? A) $64.80 B) $54.00 C) $90.00 D) $118.80
A) $64.80 Explanation: $110,000 − $50,000 excluded = $60,000 excess/$1,000 × $1.08.
This year, Mr. Cox elected to contribute $4,000 of his $95,000 salary to his Section 401(k) plan. Mr. Cox's employer made a $4,000 matching contribution. How much compensation is reported on Mr. Cox's Form W-2? A) $91,000 B) $87,000 C) $95,000 D) $99,000
A) $91,000 Explanation: $95,000 salary − $4,000 elective contribution.
On June 30, 2015, Gruen Inc. issued 2,000 shares of its publicly traded stock as compensation to its employee, Stu Barnes. On date of issuance, the stock's fair market value was $13,500. Under the terms of his 2015 compensation contract, Mr. Barnes couldn't dispose of the stock before January 1, 2019, and if he terminated his employment with Gruen before that date, he had to forfeit the stock back to Gruen. Mr. Barnes made no election with respect to the restricted stock in 2015. On January 2, 2019, Mr. Barnes, who was still a Gruen employee, sold all 2,000 shares for $47,500. What are the 2019 tax consequences to Mr. Barnes? A) He recognizes $47,500 ordinary income and zero capital gain on sale of the stock. B) He recognizes zero ordinary income and $47,500 capital gain on sale of the stock. C) He recognizes zero ordinary income and $13,500 capital gain on sale of the stock. D) He recognizes $34,000 ordinary income and $13,500 capital gain in sale of the stock.
A) He recognizes $47,500 ordinary income and zero capital gain on sale of the stock.
On June 30, 2015, Kelso Inc., a calendar year corporation, issued 2,000 shares of its publicly traded stock as compensation to its employee, Nick Penn. On date of issuance, the stock's fair market value was $13,500. Under the terms of his 2015 compensation contract, Mr. Penn couldn't dispose of the stock before February 1, 2019, and if he terminated his employment with Kelso before that date, he had to forfeit the stock back to Kelso. On February 1, 2019, the fair market value of the 2,000 shares was $20,000. Which of the following statements is true? A) If Mr. Penn elected to recognize income with respect to the restricted stock in 2015, Kelso was allowed to deduct $13,500 as employee compensation in 2015. B) Kelso was allowed to deduct $13,500 as employee compensation in 2015. C) Kelso is allowed to deduct $20,000 as employee compensation in 2019. D) None of the above is true.
A) He recognizes $47,500 ordinary income and zero capital gain on sale of the stock.
Mr. Wang's corporate employer transferred him from its Seattle office to its San Jose office. Mr. Wang incurred $18,000 of moving expenses to relocate his household to San Jose. Which of the following statements is true? A) If his employer paid him an $18,000 moving allowance, Mr. Wang must include $18,000 in gross income. B) If his employer paid him a $12,000 moving allowance, Mr. Wang is allowed a $6,000 itemized deduction for moving expenses. C) If his employer paid him a $12,000 moving allowance, Mr. Wang is allowed a $6,000 above-the line deduction. D) Regardless of the amount of any moving allowance paid by his employer, Mr. Wang is allowed an $18,000 itemized deduction for unreimbursed moving expenses.
A) If his employer paid him an $18,000 moving allowance, Mr. Wang must include $18,000 in gross income.
Eight years ago, Acnex Inc. granted Ms. Cardena a nonqualified option to purchase 1,000 shares of Acnex stock at $44 per share. On date of grant, the market price was $42 per share. This year, Ms. Cardena exercised the option when the market price was $75 per share. Which of the following statements is true? A) Ms. Cardena recognizes $31,000 ordinary income, and Acnex is allowed a $31,000 deduction this year. B) Ms. Cardena recognizes $31,000 ordinary income, and Acnex is allowed a $44,000 deduction this year. C) Ms. Cardena recognizes $33,000 ordinary income, and Acnex is allowed a $33,000 deduction this year. D) Ms. Cardena recognizes $33,000 ordinary income, and Acnex is allowed a $44,000 deduction this year.
A) Ms. Cardena recognizes $31,000 ordinary income, and Acnex is allowed a $31,000 deduction this year. Explanation: Acnex's deduction equals Ms. Cardena's $31,000 income upon exercise ($75,000 FMV − $44,000 cost).
Mr. and Mrs. Williams are the sole shareholders of Lessing, Inc., an S corporation. Last year, Lessing employed the Williams' son and paid him a $50,000 salary. During a recent IRS audit, the revenue agent discovered that the son rarely shows up for work and spends most of his time playing golf. Which of the following statements is true? A) The IRS can disallow Lessing's $50,000 deduction for the son's salary. B) The IRS can treat the $50,000 payment as a constructive dividend to the son. C) The IRS can treat the $50,000 payment as a constructive dividend to Mr. and Mrs. Williams. D) The discovery has no tax consequences to Mr. and Mrs. Williams or their son.
A) The IRS can disallow Lessing's $50,000 deduction for the son's salary.
Which of the following is not a factor considered by the courts when evaluating the reasonableness of an employee's compensation? A) The number of hours worked and the duties performed by the employee. B) The amount of compensation paid by other corporate employers in the same line of business to unrelated employees performing the same or similar services. C) The employee's education and years of experience. D) All of the above factors are considered.
D) All of the above factors are considered.
On March 1, 2015, Bema Inc. issued 600 shares of its publicly traded stock as compensation to its employee, Ms. McPhee. On date of issuance, the stock's fair market value was $12,000. Under the terms of her 2015 employment contract, Ms. McPhee couldn't dispose of the stock before July 1, 2018, and if she terminated her employment with Bema before that date, she had to forfeit the stock back to Bema. Ms. McPhee made a timely election in 2015 to accelerate income recognition with respect to the 600 shares of restricted stock. On July 1, 2018, Ms. McPhee, who was still employed by Bema, sold all 600 shares for $26,000. What are the 2018 tax consequences to Ms. McPhee? A) She recognizes $26,000 ordinary income and zero capital gain on sale of the stock. B) She recognizes zero ordinary income and $14,000 capital gain on sale of the stock. C) She recognizes zero ordinary income and $26,000 capital gain on sale of the stock. D) She recognizes $12,000 ordinary income and $14,000 capital gain in sale of the stock.
B) She recognizes zero ordinary income and $14,000 capital gain on sale of the stock.
This year, Nilo Inc. granted nonqualified stock options to 230 employees. For financial statement purposes, Nilo recorded a $179,200 expense for the estimated value of the options. As a result of this transaction, Nilo has a: A) Temporary favorable book/tax difference B) Temporary unfavorable book/tax difference C) Permanent favorable book/tax difference D) Permanent unfavorable book/tax difference
B) Temporary unfavorable book/tax difference
Lansing Corporation, a publicly held company with a 21% tax rate, paid its PEO an annual salary of $1 million plus a year-end bonus of $500,000 million. The bonus was based on a targeted amount of annual gross revenue. Ignoring payroll taxes, calculate the after-tax cost of this payment. A) $1.5 million B) $1.29 million C) $1.185 million D) $0
B) $1.29 million Explanation: Only $1 million of the PEO's alary is deductible. After-tax cost is $1.290 million ($1.5 million - $210,000 tax savings[$1 million × 21%)]).
Ms. Knox, age 34 and single, has $127,800 AGI, $108,200 of which is compensation income. Compute her maximum contribution to her Roth IRA. A) $0 B) $2,640 C) $2,860 D) $5,500
B) $2,640 Explanation: $5,500 − $2,860 ($5,500 × 0.52 [($127,800 − $120,000)/$15,000]).
Louise, age 51, quit her job and received a $70,000 distribution from her employer-sponsored qualified retirement plan. She immediately contributed $50,000 to a rollover IRA and used the remaining $20,000 to purchase a car. Compute the tax cost of the distribution if Louise has a 32% marginal tax rate on ordinary income. A) $6,400 B) $8,400 C) $21,000 D) -0-
B) $8,400 Explanation: $6,400 tax ($20,000 × 32%) + $2,000 premature withdrawal penalty a 10% penalty
Which of the following statements concerning the employer-employee relationship is true? A) An employee has the right to direct and control how her duties are performed. B) An employer generally sets the employee's work schedule. C) At the end of each tax year, an employer issues a Form 1099 to each employee reporting the compensation paid during the year. D) An employee must pay self-employment taxes.
B) An employer generally sets the employee's work schedule.
Which of the following statements concerning the client-independent contractor relationship is false? A) A client may only accept or reject the final results of the work of an independent contractor. B) An independent contractor is entitled to all the fringe benefits offered to the client's employees. C) At the end of each tax year, a client issues a Form 1099 to an independent contractor reporting the compensation paid during the year. D) An independent contractor must pay both income tax and self-employment tax.
B) An independent contractor is entitled to all the fringe benefits offered to the client's employees.
Which of the following statements regarding the tax consequences of wages is false? A) Cash basis employees must report wages in the year payment is actually or constructively received. B) Employees may elect whether or not their employer withholds income and payroll taxes from their wages. C) Whether wages are currently deductible by the employer depends on the type of services rendered by the employee. D) Wages paid to business employees are either deductible by the employer or treated as a capitalized cost.
B) Employees may elect whether or not their employer withholds income and payroll taxes from their wages.
Which of the following statements regarding fringe benefits is false? A) The general rule is that an employee fringe benefit is taxable unless the benefit is specifically excluded from the employee's gross income. B) Employers are not allowed to deduct the cost of nontaxable employee fringe benefits. C) Nontaxable fringe benefits must be provided to employees on a nondiscriminatory basis. D) None of the above is false.
B) Employers are not allowed to deduct the cost of nontaxable employee fringe benefits.
Mr. Scott, age 46, quit his job with MNP Inc. and withdrew the $184,000 balance in his Section 401(k) plan. Mr. Scott immediately deposited the withdrawal in a new rollover Roth IRA with a local bank. Which of the following statements is false? A) Mr. Scott must include the $184,000 withdrawal in gross income. B) Mr. Scott must pay a 10% premature withdrawal penalty. C) Future withdrawals from the rollover Roth IRA will be nontaxable. D) None of the statements is false.
B) Mr. Scott must pay a 10% premature withdrawal penalty. Explanation: Taxable rollovers into Roth IRAs are not subject to the premature withdrawal penalty.
Mr. and Mrs. Alexander, ages 43 and 44, each earn substantial salaries but do not participate in any type of employer-sponsored qualified retirement plan. Which of the following is true? A) The couple can each contribute $5,500 to a traditional IRA and take an $11,000 itemized deduction on their joint Form 1040. B) The couple can each contribute $5,500 to a traditional IRA and take an $11,000 above-the-line deduction on their joint Form 1040. C) The couple can each contribute $2,750 to a traditional IRA and take a $5,500 above-the-line deduction on their joint Form 1040. D) The couple can each contribute $2,750 to a traditional IRA and take a $5,500 itemized deduction on their joint Form 1040.
B) The couple can each contribute $5,500 to a traditional IRA and take an $11,000 above-the-line deduction on their joint Form 1040. Explanation: Each spouse on a joint return can make the maximum contribution to a traditional IRA. The deduction for such contributions is above-the-line.
Tony's marginal income tax rate is 32%, and he pays FICA tax on his entire salary (7.65%). Tony's employer offered him a choice between $5,000 additional salary or a nontaxable fringe benefit. Tony would have to pay $3,400 to purchase the benefit directly. Which of the following statements is true? A) The fringe benefit and the additional salary have the same after-tax value. B) The fringe benefit is worth $383 more than the additional salary. C) The additional salary is worth $600 more than the fringe benefit. D) None of the above is true.
B) The fringe benefit is worth $383 more than the additional salary. Explanation: $5,000 additional salary − $1,600 income tax − $383 FICA tax = $3,017 < $3,400.
Harold Biggs is provided with $200,000 coverage under his employer's group-term life insurance plan. Which of the following statements is true? A) The value of $50,000 coverage is included in Harold's gross income. B) The value of $150,000 coverage is included in Harold's gross income. C) The value of $200,000 coverage is included in Harold's gross income. D) Harold's life insurance coverage is a nontaxable fringe benefit.
B) The value of $150,000 coverage is included in Harold's gross income. Explanation: Only the value of the first $50,000 of group-term life insurance coverage is a nontaxable fringe benefit.
Mr. and Mrs. Pointer each contributed $1,800 to their traditional IRAs. Each spouse actively participates in an employer-sponsored qualified retirement plan. Compute the deductible IRA contribution on their joint return if their AGI before such deduction is $111,970. A) $3,600 B) $1,975 C) $1,625 D) $0
C) $1,625 Explanation: $3,600 − $1,975 ($3,600 × 0.5485 [($111,970 − $101,000)/$20,000]).
Mr. Thano, age 47, withdrew $22,000 from his employer-sponsored qualified retirement plan to pay for his daughter's wedding. Compute the tax cost of the withdrawal if Mr. Thano has a 37% marginal tax rate on ordinary income. A) $2,200 B) $8,140 C) $10,340 D) $11,000
C) $10,340 8,140 tax ($22,000 × 37%) + $2,200 premature withdrawal penalty.
Mr. and Mrs. Lawry, both age 60, each make the maximum contribution to their traditional IRAs. Mr. Lawry is an active participant in a section 401(k) plan, but Mrs. Lawry is not an active participant in any other qualified plan. If their joint AGI before any IRA deduction is $144,900, compute their AGI. A) $144,900 B) $139,400 C) $138,400 D) $131,900
C) $138,400 Explanation: Mr. Lawry's $6,500 contribution is nondeductible because he is an active participant in another plan and AGI exceeds $121,000. Mrs. Lawry's $6,500 contribution is deductible because AGI is less than $189,000.
Lansing Corporation, a publicly held company with a 21% tax rate, paid its PEO an annual salary of $2.3 million. Ignoring payroll taxes, calculate the after-tax cost of this payment. A) $2.3 million B) $1.817 million C) $2.09 million D) $0
C) $2.09 million Explanation: Only $1 million of the PEO's salary is deductible. After-tax cost is $2.09 ($2.3 million - $210,000 tax savings [$1 million × 21%]).
Lawrence is a U.S. citizen who has worked in his employer's Paris office for the past five years. Compute Lawrence's 2018 AGI if his only item of income was his $130,000 salary. A) $130,000 B) $104,100 C) $24,100 D) $0
C) $24,100 Explanation: $130,000 − $105,900 foreign earned income exclusion.
Mrs. Lee, age 70, withdrew $40,000 from her traditional IRA this year. The balance in the account at year-end was $96,600, which included $28,000 of nondeductible contributions. Compute the taxable portion of the $40,000 withdrawal. A) $0 B) $8,199 C) $31,801 D) $40,000
C) $31,801 Explanation: $40,000 × ($28,000/$136,600 [$96,600 + $40,000]) = $8,199 nontaxable withdrawal and $31,801 taxable withdrawal.
Six years ago, Linus Corporation granted Pauline a nonqualified option to purchase 5,000 shares of Linus stock for $13 per share. On date of grant, the market price was $11 per share. Last year, Pauline exercised the option when the market price was $47 per share. This year, she sold the stock for $40 per share. Compute Pauline's gain or loss recognized on sale. A) $135,000 gain B) $10,000 loss C) $35,000 loss D) No gain or loss on sale
C) $35,000 loss Explanation: $200,000 amount realized on sale − $235,000 basis ($65,000 cost + $170,000 income recognized on exercise).
Peter is a 20-year-old college student. His AGI consists of $12,000 interest and dividend income from a trust fund and $4,180 of wages from a part-time job. Compute Peter's maximum IRA contribution: A) $0 B) $3,000 C) $4,180 D) $5,500
C) $4,180 Explanation: IRA contributions are limited to the taxpayer's earned income.
Six years ago, HOPCO granted Lin Sing a nonqualified option to purchase 1,000 shares of HOPCO stock at $55 per share. On date of grant, the market price was $50 per share. This year, Lin Sing exercised the option when the market price was $64 per share. How much ordinary income does Lin Sing recognize because of the exercise? A) $0 B) $5,000 C) $9,000 D) $14,000
C) $9,000 Explanation: Bargain element is $14,000 ($64,000 FMV of 1,000 shares − $55,000 cost).
In 2008, Mr. Delgado exercised an option to purchase 1,000 shares of his employer's stock for $29 per share when the market price was $65 per share. This year, Mr. Delgado sold the stock for $80 per share. Which of the following statements is false? A) If the option was an ISO, Mr. Delgado recognized a $51,000 gain on sale. B) If the option was nonqualified, Mr. Delgado recognized a $15,000 gain on sale. C) If the option was an ISO, Mr. Delgado has a $36,000 AMT preference item this year. D) None of the above is false.
C) If the option was an ISO, Mr. Delgado has a $36,000 AMT preference item this year. Explanation: If the option was an ISO, Mr. Delgado had a $36,000 preference item in 2008.
Which of the following statements regarding a Roth IRA is false? A) Contributions to a Roth IRA are nondeductible. B) A Roth IRA is tax exempt. C) Individuals of any age can make tax-exempt withdrawals from a Roth IRA. D) High-income individuals are not allowed to contribute directly to a Roth IRA.
C) Individuals of any age can make tax-exempt withdrawals from a Roth IRA. Explanation: An individual must have reached age 59½ before he can make a qualified (tax-exempt) withdrawal from a Roth IRA.
Which of the following statements comparing traditional and Roth IRAs is false? A) For a 57-year old individual, the maximum allowable contribution to either type of IRA is $6,500. B) Contributions to traditional IRAs may be deductible; contributions to Roth IRAs are nondeductible. C) Individuals who have reached age 70½ must begin liquidating either type of IRA. D) Individuals may have to pay a premature withdrawal penalty from either type of IRA.
C) Individuals who have reached age 70½ must begin liquidating either type of IRA.
Jason Inc. maintains a qualified profit-sharing plan for its employees. This year, Jason contributed $2,300 to Ms. Preston's profit-sharing account. Which of the following statements is true? A) Jason can deduct the contribution, and Ms. Preston must include the contribution in gross income. B) Jason can't deduct the contribution, but Ms. Preston must include the contribution in gross income. C) Jason can deduct the contribution, but Ms. Preston does not include the contribution in gross income. D) Jason can't deduct the contribution, and Ms. Preston does not include the contribution in gross income.
C) Jason can deduct the contribution, but Ms. Preston does not include the contribution in gross income.
In 2018, Jenko Inc., a calendar year taxpayer, issued 1,000 shares of its publicly traded stock as a bonus to its employee, Mrs. Leder. On the date of issuance, the stock's fair market value was $25,000, and Mrs. Leder's ownership rights in the stock were unrestricted. Which of the following statements is true? A) Mrs. Leder doesn't recognize income on receipt of the stock, and her tax basis in the stock is zero. B) Mrs. Leder doesn't recognize income on receipt of the stock, and her tax basis in the stock is $25,000. C) Mrs. Leder recognizes $25,000 of ordinary income on receipt of the stock, and her tax basis in the stock is $25,000. D) None of the above is true.
C) Mrs. Leder recognizes $25,000 of ordinary income on receipt of the stock, and her tax basis in the stock is $25,000.
Four years ago, Acnex Inc. granted Ms. Cardena an incentive stock option (ISO) to purchase 1,000 shares of Acnex stock at $44 per share. On date of grant, the market price was $42 per share. This year, Ms. Cardena exercised the ISO when the market price was $75 per share. Which of the following statements is true? A) Ms. Cardena recognizes $31,000 ordinary income, and Acnex is allowed a $31,000 deduction this year. B) Ms. Cardena recognizes $31,000 ordinary income, but Acnex is allowed no deduction this year. C) Ms. Cardena recognizes no ordinary income, and Acnex is allowed no deduction this year. D) Ms. Cardena recognizes no ordinary income, but Acnex is allowed a $31,000 deduction this year.
C) Ms. Cardena recognizes no ordinary income, and Acnex is allowed no deduction this year.
Which of the following is not a benefit of nonqualified deferred compensation plans? A) Nonqualified plans may discriminate in favor of highly compensated executives. B) There is no limit on the amount of nonqualified deferred compensation that can be provided to an employee. C) Nonqualified deferred compensation plans are less risky for participating employees than qualified retirement plans. D) Employers do not have to expend cash to fund a nonqualified plan.
C) Nonqualified deferred compensation plans are less risky for participating employees than qualified retirement plans.
Which of the following statements regarding employee versus independent contractor status is false? A) The determination as to whether a worker is an employee or an independent contractor is based on a subjective set of guidelines. B) An employer has a financial incentive to classify a worker as an independent contractor instead of an employee. C) The IRS has a higher probability of collecting income and payroll taxes from an independent contractor than from an employee. D) If the IRS reclassifies a worker from independent contractor to employee, the employer can become liable for the employee's share of unpaid payroll taxes.
C) The IRS has a higher probability of collecting income and payroll taxes from an independent contractor than from an employee.
Which of the following statements regarding the foreign earned income exclusion is false? A) Expatriates may not claim a foreign tax credit for foreign tax paid on excluded income. B) The exclusion is limited to an inflation-adjusted annual dollar amount. C) The exclusion is available to any U.S. citizen employed by a foreign company. D) The exclusion is available to any U.S. citizen working and residing in a foreign country.
C) The exclusion is available to any U.S. citizen employed by a foreign company.
Vernon Inc. needs an additional worker on a multi-year project. Vernon could either hire an employee for a $72,000 annual salary or engage an independent contractor for a $75,000 annual fee. If Vernon's marginal income tax rate is 21%, which option minimizes the after-tax cost of obtaining the worker?
Correct answer: The independent contractor option is the most cost effective. Payroll tax for the employee would be $5,508 = $72,000 × 7.65%. After-tax cost of employee = $59,651 = [($70,000 + $5,508) × (1 − 21%)]. After-tax cost of independent contractor = $59,250 = $75,000 × (1 − 21%).
What is the maximum IRA contribution that Mr. Higgins can make under each of the following assumptions? a. He is age 22 and single. His only income is $14,000 of interest and dividends from a trust fund. b. He is age 30 and single. His only income is a $35,000 distributive share of ordinary business income from a partnership. c. He is age 60 and single. His only income is $44,000 wages from his job. d. He is 45 and files a joint return with his wife. His sole proprietorship generates an $8,200 loss, and his wife's salary is $50,000.
Correct answer: a. $0 contribution. b. $5,500 contribution. c. $6,500 contribution. d. $5,500 contribution.
Lars withdrew $20,000 from a retirement account and used the money to buy a new car. Assuming that his marginal rate on ordinary income is 32%, compute the tax cost of the withdrawal in each of the following cases.a. Lars is 40 years old. He withdrew the money from a personal savings account. b. Lars is 40 years old. He withdrew the money from his employer-sponsored qualified plan after resigning from his job. c. Lars is 65 years old. He withdrew the money from a Roth IRA.
Correct answer: a. $0. b. $8,400 = ($20,000 × 10% penalty tax) + ($20,000 × 32% income tax). c. $0
This year, Haven Corporation granted a nonqualified stock option to Olivia to buy 5,000 shares of Haven stock for $20 for five years. At date of grant, Haven stock was selling on the Nasdaq for $19 per share. For financial statement purposes, Haven recorded $16,500 compensation expense for the estimated value of the option. a. How much income must Olivia recognize as a result of the grant of the option? b. Can Haven deduct the $16,500 compensation expense on this year's tax return? c. Assuming a 21% tax rate, compute Haven's deferred tax asset or deferred tax liability (identify which) resulting from the $16,500 compensation expense.
Correct answer: a. $0. b. No. c. $16,500 × 21% = $3,465 deferred tax asset.
This year, Haven Corporation granted a nonqualified stock option to Olivia to buy 5,000 shares of Haven stock for $20 for five years. At date of grant, Haven stock was selling on Nasdaq for $19 per share. For financial statement purposes, Haven recorded $16,500 compensation expense for the estimated value of the option. Five years after Haven granted the option to Olivia, she exercised it on a day when Haven stock was selling for $27 per share. a. How much income must Olivia recognize in the year of exercise? b. What is Haven's tax deduction in the year of exercise? c. What is the effect of the exercise on Haven's book income and deferred taxes? Correct answer: a. 5,000 × ($27 − $20) = $35,000 ordinary income. b. $35,000. c. The exercise transaction has no effect on book income. Haven will reverse the original $3,465 deferred tax asset ($16,500× 21%).
Correct answer: a. 5,000 × ($27 − $20) = $35,000 ordinary income. b. $35,000. c. The exercise transaction has no effect on book income. Haven will reverse the original $3,465 deferred tax asset ($16,500× 21%).
Which of the following statements regarding Keogh plans is false? A) Keogh plans provide a tax-deferred retirement savings option for self-employed individuals. B) Keogh plans must be administered by an independent trustee. C) Keogh plans can be either defined-benefit or defined-contribution plans. D) A self-employed person with a Keogh plan is not required to provide retirement benefits to his or her employees through the plan.
D) A self-employed person with a Keogh plan is not required to provide retirement benefits to his or her employees through the plan.
Mr. Sherman incurred $7,000 of employment-related business expenses. Which of the following statements is true? A) If his employer reimbursed him for these expenses, Mr. Sherman must include the reimbursement in gross income. B) If his employer reimbursed him for $3,000 of the expenses, Mr. Sherman is allowed a $4,000 above-the-line deduction. C) If his employer reimbursed him for $3,000 of the expenses, Mr. Sherman is allowed a $4,000 itemized deduction. D) If his employer reimbursed him for $3,000 of the expenses, Mr. Sherman has a $4,000 nondeductible expense.
D) If his employer reimbursed him for $3,000 of the expenses, Mr. Sherman has a $4,000 nondeductible expense.
Mr. Paul, age 73 and single, earned a $150,000 salary (AGI) as a university professor. He no longer participates in the university's qualified retirement plan. Which of the following is true? A) Mr. Paul can make a $6,500 deductible contribution to a traditional IRA. B) Mr. Paul can make a $6,500 nondeductible contribution to a traditional IRA. C) Mr. Paul can make a $6,500 nondeductible contribution to a Roth IRA. D) Mr. Paul can't make an IRA contribution.
D) Mr. Paul can't make an IRA contribution.
Mr. Smith, age 61, withdrew $12,000 from his traditional IRA this year. The balance in the account at year-end was $183,700, which included $40,000 of nondeductible contributions. Compute the taxable portion of the $12,000 withdrawal. A) $0 B) $2,453 C) $12,000 D) None of the above
D) None of the above Explanation: $12,000 × ($40,000/$195,700 [$183,700 + $12,000]) = $2,453 nontaxable withdrawal and $9,547 taxable withdrawal.
Mrs. Soon retired at age 68 and withdrew the entire $77,100 balance from an IRA to buy a sailboat. She opened this account in 1999. Which of the following statements is false? A) If the account is a Roth IRA, none of the withdrawal is taxable. B) If the account is a traditional IRA to which Mrs. Soon made $32,000 nondeductible contributions, $45,100 of the withdrawal is taxable. C) If the account is a traditional IRA funded entirely with deductible contributions, the entire $77,100 withdrawal is taxable. D) None of the above is false.
D) None of the above is false.
Which of the following statements concerning qualified retirement plans is false? A) Employer contributions to the plan are not included in the employees' gross income. B) The plan is tax-exempt so that earnings can accumulate on a before-tax basis. C) Employer contributions are deductible in the year of payment. D) None of the above is false.
D) None of the above is false.
Wallace Corporation needs an additional worker on a multiyear project. It could hire an employee for a $30,000 annual salary. Alternatively, it could engage an independent contractor for a $35,000 annual fee. Which of the following is true? A) Wallace must withhold payroll tax from the salary or the fee. B) Wallace must withhold federal and state income tax from the salary or the fee. C) Wallace must issue a Form W-2 to the employee or the independent contractor. D) None of the above is true.
D) None of the above is true. Explanation: Wallace would not withhold any taxes from the fee paid to the independent contractor and would issue a Form 1099 instead of a Form W-2.
Six years ago, HOPCO granted Ms. Cardena a nonqualified option to purchase 1,000 shares of HOPCO stock at $12 per share. On date of grant, the market price was $10 per share. This year, Ms. Cardena exercised the option when the market price was $33 per share. Compute HOPCO's deduction resulting from the exercise. A) $0 B) $12,000 C) $23,000 D) None of the above.
D) None of the above. Explanation: HOPCO's deduction equals Ms. Cardena's $21,000 income upon exercise ($33,000 FMV − $12,000 cost).
This year, Nilo Inc. granted incentive stock options (ISO) to 230 employees. For financial statement purposes, Nilo recorded a $179,200 expense for the estimated value of the ISOs. As a result of this transaction, Nilo has a: A) Temporary favorable book/tax difference B) Temporary unfavorable book/tax difference C) Permanent favorable book/tax difference D) Permanent unfavorable book/tax difference
D) Permanent unfavorable book/tax difference Explanation: The unfavorable difference is permanent because Nilo is never allowed a deduction with respect to the ISOs.
Lana, an employee of Compton University, paid $1,500 for professional journal subscriptions and $1,000 membership dues to academic organizations. Her employer reimbursed her only for the $1,000 membership dues. Which of the following statements is true? A) Lana must include the $1,000 reimbursement in gross income. B) Lana is allowed an itemized deduction for the $1,500 paid for the journal subscriptions. C) Lana is allowed an above-the-line deduction for the $1,500 paid for the journal subscriptions. D) The $1,500 paid for the journal subscriptions is a nondeductible expense.
D) The $1,500 paid for the journal subscriptions is a nondeductible expense. Explanation: Unreimbursed employee business expenses are nondeductible.
Mr. and Mrs. Williams are the sole shareholders of Lessing, Inc., a regular corporation. Last year, Lessing employed the Williams' son and paid him a $50,000 salary. During a recent IRS audit, the revenue agent discovered that the son rarely shows up for work and spends most of his time playing golf. Which of the following statements is true? A) The IRS can treat the $50,000 payment as a constructive dividend to the son. B) The IRS can treat the $50,000 payment as a constructive dividend to Mr. and Mrs. Williams. C) The IRS can disallow Lessing's $50,000 deduction for the son's salary. D) The IRS can treat the $50,000 payment as a constructive dividend to Mr. and Mrs. Williams and can disallow Lessing's $50,000 deduction for the son's salary.
D) The IRS can treat the $50,000 payment as a constructive dividend to Mr. and Mrs. Williams and can disallow Lessing's $50,000 deduction for the son's salary.
This year, Mrs. Pike's compensation from her corporate employer consisted of $325,000 current salary and $75,000 unfunded deferred compensation payable upon her retirement at age 66. Which of the following statements is true? A) This year, Mrs. Pike must include $400,000 in gross income, and her employer is allowed a $400,000 deduction. B) This year, Mrs. Pike must include $325,000 in gross income, and her employer is allowed a $400,000 deduction. C) This year, Mrs. Pike must include $400,000 in gross income, and her employer is allowed a $325,000 deduction. D) This year, Mrs. Pike must include $325,000 in gross income, and her employer is allowed a $325,000 deduction.
D) This year, Mrs. Pike must include $325,000 in gross income, and her employer is allowed a $325,000 deduction.
