Income Tax Chapter 5

Ray and Carin are partners in an accounting firm. The partners have entered into an arm's length agreement requiring Ray to purchase Carin's partnership interest from Carin's estate if she dies before Ray. The price is set at 120% of the book value of Carin's partnership interest at the time of her death. Ray purchased an insurance policy on Carin's life to fund this agreement. After Ray had paid $45,000 in premiums, Carin was killed in an automobile accident and Ray collected $800,000 of life insurance proceeds. Ray used the life insurance proceeds to purchase Carin's partnership interest. a. Ray must include $______ in his gross income from receiving the life insurance proceeds.

Answer: $0. A life insurance policy (other than once 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. The Code, however, provides four exceptions to the rule. These exceptions permit exclusion treatment for transfers to the following: The insured under the policy. A partner of the insured. A partnership in which the insured is a partner. A corporation in which the insured is an officer or a shareholder. A transferee whose basis in the policy is determined by reference to the transferor's basis. Life insurance proceeds paid to the beneficiary because of the death of the insured are exempt from income tax. Ray is the beneficiary of the life insurance policy and can exclude the proceeds of $800,000 from his gross income.

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 28% 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. a. Rosa puts $4,000 into her flexible benefits account, and her actual expenses are $5,000. What is her cost of underestimating the expenses?

Answer: $280. Under a flexible spending plan, the employee accepts lower cash compensation in return for the employer agreeing to pay certain costs that the employer can pay without the employee recognizing gross income. The employee estimates his or her medical expenses for the upcoming year and agrees to a salary reduction equal to the estimated expenses. The employer then pays or reimburses the employee for the expenses incurred, with a ceiling of the amount of the salary reduction. If the employee's actual expenses are less than the reduction in cash compensation, the employee cannot recover the difference. Hence, these plans are often referred to as "use or lose" plans. If Rosa underfunds the account by $1,000, the cost of the error is her marginal tax rate times the underfunded amount or $280 (.28 × $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 28% 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? (Assume this is a "use or lose" plan).

Answer: $720. Per the discussion above, if Rosa overfunds the account by $1,000, the cost of the error is $720 [(1 - .28) × $1,000].

Tim is the vice president of western operations for Maroon Oil Company and is stationed in San Francisco. He is required to live in an employer-owned home, which is three blocks from his company office. The company-provided home is equipped with high-speed internet access and several telephone lines. Tim receives telephone calls and e-mails that require immediate attention any time of day or night, the company's business is spread all over the world. A full-time administrative assistant resides in the house to assist Tim with the urgent business matters. Tim often uses the home for entertaining customers, suppliers, and employees. The fair market value of comparable housing is $9,000 per month. Tim is also provided with free parking at his company's office. The value of the parking is $350 per month b. The amount associated with the free parking that Tim must include in his gross income per month is $____

Answer: $95. Qualified transportation fringe benefits include qualified parking. For qualified parking, the limit on the exclusion is $255 per month. Therefore, Tim would include $95 ($350 - $255) per month because the benefit exceeds the qualified parking monthly exclusion limit for 2017 of $255.

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 28% 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. c. What is Rosa's cost of underfunding as compared with the cost of overfunding the flexible benefits account?

Answer: The underfunding error costs 39% of the cost of overfunding. The cost of underfunding is a .28 × error, and the cost of overfunding is a .72 (1 - .28) × error; that is, the underfunding error costs only 39% (.28/.72) of the cost of overfunding.

Ray and Carin are partners in an accounting firm. The partners have entered into an arm's length agreement requiring Ray to purchase Carin's partnership interest from Carin's estate if she dies before Ray. The price is set at 120% of the book value of Carin's partnership interest at the time of her death. Ray purchased an insurance policy on Carin's life to fund this agreement. After Ray had paid $45,000 in premiums, Carin was killed in an automobile accident and Ray collected $800,000 of life insurance proceeds. Ray used the life insurance proceeds to purchase Carin's partnership interest. The insurance company paid Ray $16,000 interest on the life insurance proceeds during the period Carin's estate was in administration. During this period, Ray had left the insurance proceeds with the insurance company. Is this interest taxable?

Answer: Yes. Although life insurance proceeds paid to the beneficiary because of the death of the insured are exempt from income tax, any interest earned and paid on the proceeds is fully taxable. The $16,000 of interest earned on the life insurance proceeds left with the insurance company is included in Ray's gross income.

Leigh sued an overzealous bill collector and received the following settlement: Damage to her automobile that the collector attempted to repossess $3,300 Physical damage to her arm caused by the collector $15,000 Loss of income while her arm was healing $6,000 Punitive damages $80,000 b. Assume that Leigh also collected $25,000 of damages for slander to her personal reputation caused by the bill collector misrepresenting the facts to Leigh's employer and other creditors. Is this $25,000 included in Leigh's gross income?

Answer: Yes. Only damages received on account of physical personal injury or physical sickness can be excluded from gross income. The $25,000 is included in Leigh's gross income, because it did not arise out of a physical personal injury.

b. Scott is an executive for an international corporation located in New York City. Often he works late, taking telephone calls from the company's European branch. Scott often stays in a company-owned condominium when he has a late-night work session. The condominium is across the street from the company office and has the technology needed to communicate with employees and customers throughout the world. Because the lodging is provided as __________, Scott ________________ in gross income.

Answer: a convenience for the employer; is not required to include anything. Scott is not required to include anything in gross income for the use of the condominium assuming the lodging is for the convenience of the employer. Also, because of the close proximity of the condominium to the office, the condominium is considered to be on the employer's business premises according to the Tax Court.

Ira recently moved to take a job. For the first month on the new job, Ira was searching for a home to purchase or rent. During this time, his employer permitted Ira to live in an apartment the company maintains for customers during the buying season. The month that Ira occupied the apartment was not during the buying season, and the apartment would not otherwise have been occupied. The use of the apartment should qualifies as ______ and therefore is ______ gross income.

Answer: a no-additional-cost service; excluded from. § 119 excludes employer-provided lodging from income if it is for the convenience of the employer or if the employee is required to accept the lodging as a condition of employment. Under no-additional-cost service, the services will be nontaxable if all of the following conditions are satisfied: (1) The employee receives services, as opposed to property, (2) the employer does not incur substantial additional cost, including forgone revenue, in providing the services to the employee, and (3) the services are offered to customers in the ordinary course of the business in which the employee works. Apparently Ira is not being provided the housing for the convenience of his employer. However, the use of the apartment should qualify as a no-additional-cost service because the apartment would otherwise be vacant.

Adrian was awarded an academic scholarship to State University for the 2017-2018 academic year. He received $6,500 in August and $7,200 in December 2017. Adrian had enough personal savings to pay all expenses as they came due. Adrian's expenditures for the relevant period were as follows: Tuition, August 2017 $3,700 Tuition, January 2018 3,750 Room and board August-December 2017 2,800 January-May 2018 2,500 Books and educational supplies August-December 2017 1,000 January-May 2018 1,200 What amount, if any, must Adrian include in his gross income for 2017 and 2018? If an amount is zero, enter "0". 2017 = ______ 2018 = ______

Answers: $0; $4050. Amounts received for room and board are not excludible and are treated as earned income for purposes of calculating the standard deduction for a taxpayer who is another taxpayer's dependent. Frequently, the scholarship recipient is a cash basis taxpayer who receives the money in one tax year but pays the educational expenses in a subsequent year. The amount eligible for exclusion may not be known at the time the money is received. In that case, the transaction is held open until the educational expenses are paid. Adrian received a total of $13,700 and spent $9,650 ($3,700 + $3,750 + $1,000 + $1,200) on tuition, books, and supplies. The amount received for room and board is not excludible from gross income. Therefore, he must include $4,050 ($13,700 - $9,650) in gross income. When he received the money in 2017, Adrian's total expenses for the period covered by the scholarship were not known. Therefore, he is allowed to defer reporting the income until 2018, when all the uncertainty is resolved.

Eagle Life Insurance Company pays its employees $.30 per mile for driving their personal automobiles to and from work. The company reimburses each employee who rides the bus $100 a month for the cost of a pass. Tom, in his Mazda 2-seat Roadster, collected $100 for his automobile mileage, and Mason received $100 as reimbursement for the cost of a bus pass. If an amount is zero, enter "0". Assume that Tom and Mason are in the 28% marginal tax bracket and the actual before-tax cost for Tom to drive to and from work is $0.30 per mile. What are Tom's and Mason's after-tax costs of commuting to and from work? Tom's after-tax cost is $_______ and Mason's after-tax cost is $________ for commuting to and from work.

Answers: $28; $0. If Tom's actual cost was $0.30 per mile, then he paid $100 for transportation costs and was reimbursed the same amount. Therefore, Tom's before-tax cost was $0. However, Tom is required to include the $100 in gross income and will pay an additional $28 ($100 x 0.28) tax on the reimbursement. His after-tax cost of commuting is equal to the income tax of $28. As discussed above, Mason's reimbursement is not taxable. Therefore, his after-tax cost of commuting is $0 because he is reimbursed for the out-of-pocket cost and is not required to include the reimbursement in income.

Leigh sued an overzealous bill collector and received the following settlement: Damage to her automobile that the collector attempted to repossess $3,300 Physical damage to her arm caused by the collector $15,000 Loss of income while her arm was healing $6,000 Punitive damages $80,000 a. Regarding Leigh's settlement, classify the following as either "Included in" or "Excluded from" her gross income. * Damage to her automobile that the collector attempted to repossess (Include / Exclude) • Physical damage to her arm caused by the collector (Include / Exclude) • Loss of income while her arm was healing (Include / Exclude) • Punitive damages (Include / Exclude)

Answers: Excluded from; Excluded from; Excluded from; Included in. Generally, reimbursement for a loss of income is taxed the same as the income replaced. The recovery of an expense is not income unless the expense was deducted. Damages that are a recovery of the taxpayer's previously deducted expenses are generally taxable under the tax benefit rule. A payment for damaged or destroyed property is treated as an amount received in a sale or exchange of the property. Thus, the taxpayer has a realized gain if the damages payments received exceed the property's basis. In terms of personal injury damages, a distinction is made between compensatory damages and punitive damages. Compensatory damages are intended to compensate the taxpayer for the damages incurred. Only those compensatory damages received on account of physical personal injury or physical sickness can be excluded from gross income. Punitive damages are amounts the person who caused the harm must pay to the victim as punishment for outrageous conduct.

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 a. Determine the effect of the scholarship on Sally's gross income. Tuition and fees (Include/Exclude) Housing and meals (Include/Exclude) Books and supplies (Include/Exclude) Transportation (Include/Exclude)

Answers: Excluded from; Included in; Excluded from; Included in. The scholarship rules are intended to provide exclusion treatment for education-related benefits but not for compensation for services. The athletic scholarship is considered to be a payment to further the recipient's education and is not compensation for services. According to the Regulations, "a scholarship is an amount paid or allowed to, or for the benefit of, an individual to aid such individual in the pursuit of study or research." The recipient must be a candidate for a degree at an educational institution. Therefore, the scholarship rules apply as follows: Tuition and fees Excluded from. A scholarship recipient may exclude from gross income the amount used for tuition and related expenses (fees, books, supplies, and equipment required for courses), depending on the conditions of the grant. Housing and meals Included in. Amounts received for room and board are not excludible. Books and supplies Excluded from. See the explanation for tuition and fees above. Transportation Included in. Amounts received for transportation are not excludible

Ray and Carin are partners in an accounting firm. The partners have entered into an arm's length agreement requiring Ray to purchase Carin's partnership interest from Carin's estate if she dies before Ray. The price is set at 120% of the book value of Carin's partnership interest at the time of her death. Ray purchased an insurance policy on Carin's life to fund this agreement. After Ray had paid $45,000 in premiums, Carin was killed in an automobile accident and Ray collected $800,000 of life insurance proceeds. Ray used the life insurance proceeds to purchase Carin's partnership interest. When Ray paid $800,000 for Carin's partnership interest, priced as specified in the agreement, the fair market value of Carin's interest was $1,000,000. Indicate whether the following statements are "True" or "False" regarding how much, if any, Ray would include in his gross income from this bargain purchase. • Since Ray did not recognize a gain on the purchase, Ray would include nothing from the transaction in his gross income. True • Ray would include the difference between the purchase price and what he paid in his gross income.

Answers: True; False. Ray did not recognize a gain on the bargain purchase. Ray simply got a good price on the purchase under an arm's length contract.

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. Indicate whether the following statements are "True" or "False" regarding 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 and is included in his gross income. • The scholarship is simply a payment to assist children of employees seeking an education and so is excluded from Willy's father's gross income. • The $6,000 scholarship is taxable to Willy since he received it as a result of a contest.

Answers: True; False; False. Some employers make scholarships available solely to the children of key employees. The tax objective of these plans is to provide a nontaxable fringe benefit to the executives by making the payment to the child in the form of an excludible scholarship. However, the IRS has ruled that the payments are generally includible in the gross income of the parent-employee.

Adrian was awarded an academic scholarship to State University for the 2017-2018 academic year. He received $6,500 in August and $7,200 in December 2017. Adrian had enough personal savings to pay all expenses as they came due. Adrian's expenditures for the relevant period were as follows: Tuition, August 2017 $3,700 Tuition, January 2018 3,750 Room and board August-December 2017 2,800 January-May 2018 2,500 Books and educational supplies August-December 2017 1,000 January-May 2018 1,200 Regarding Adrian's scholarship, indicate whether the following statements are "True" or "False". a. When Adrian received the money in 2017, his total expenses for the academic year were not known. Therefore, he is allowed to defer reporting the income until 2018, when the uncertainty is resolved. b. The amount Adrian spent on tuition, books, and educational supplies in 2018 will not be excludible, since the scholarship was awarded in 2017. c. Adrian may exclude from gross income the amount used for tuition, books, and educational supplies in 2017 and 2018. d. The amount Adrian spent on room and board is excludible.

Answers: True; False; True; False. The scholarship rules are intended to provide exclusion treatment for education-related benefits but not for compensation for services. The athletic scholarship is considered to be a payment to further the recipient's education and is not compensation for services. According to the Regulations, "a scholarship is an amount paid or allowed to, or for the benefit of, an individual to aid such individual in the pursuit of study or research." The recipient must be a candidate for a degree at an educational institution. Frequently, the scholarship recipient is a cash basis taxpayer who receives the money in one tax year but pays the educational expenses in a subsequent year. The amount eligible for exclusion may not be known at the time the money is received. In that case, the transaction is held open until the educational expenses are paid.

Laura was recently diagnosed with cancer and has begun chemotherapy treatments. A cancer specialist has stated that Laura has less than one year to live. She has incurred a many of medical bills and other general living expenses and is in need of cash. Therefore, she is considering selling stock that cost $35,000 and has a fair market value of $50,000. This amount would be sufficient to pay her medical bills. However, she has read about a company (the Vital Benefits Company) that would purchase her life insurance policy for $50,000. She has paid $30,000 in premiums on the policy. Assume that Laura is a dependent child and that her mother owns the stock and the life insurance policy, which is on the mother's life. Regarding the following alternatives for raising cash, indicate which are "True" and which are "False". • The realized gain on the life insurance policy will not be eligible for capital gain treatment. True • Capital gain treatment would apply to the sale of the stock by Laura's mother. True • Regardless of how the medical bills are financed, Laura's mother will not be allowed to take an itemized deduction for the medical expenses. False • The realized gain on the life insurance policy will be excluded from the gross income of Laura's mother.

Answers: True; True; False; False. • The realized gain on the life insurance policy would not be eligible for capital gain treatment. True. The mother's recognized gain of $20,000 will not be eligible for capital gain treatment, because cashing in the life insurance policy is not considered a "sale or exchange," which is a requisite for capital gain treatment. • Capital gain treatment would apply to the sale of the stock by Laura's mother. True. Capital gain treatment (same as Laura) would apply to the $15,000 gain on the sale of the stock by Laura's mother. • Regardless of how the medical bills are financed, Laura's mother will not be allowed to take an itemized deduction for the medical expenses. False. Regardless of how the medical bills are financed, Laura's mother would be allowed to take an itemized deduction for the medical expenses paid (less the AGI floor) for her dependent daughter assuming that she itemizes her deductions. • The realized gain on the life insurance policy will be excluded from the gross income of Laura's mother. False. The $20,000 realized gain (from above) on the life insurance policy would be included in the gross income of Laura's mother. Laura's mother cannot qualify for the exclusion, because she is not terminally ill.

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. a. For the statements below, indicate whether they are "True" or "False" regarding how the amounts received by Billy should be treated for tax purposes 1. The $100,000 received is nontaxable. 2. The $50,000 received is nontaxable. 3. The $15,000 received is nontaxable.

Answers: True; True; True. A person who suffers harm caused by another is often entitled to compensatory damages. The tax consequences of the receipt of damages depend on the type of harm the taxpayer has experienced. The taxpayer may seek recovery for (1) a loss of income; (2) expenses incurred; (3) property destroyed; or (4) personal injury. Generally, reimbursement for a loss of income is taxed the same as the income replaced. The recovery of an expense is not income unless the expense was deducted. Damages that are a recovery of the taxpayer's previously deducted expenses are generally taxable under the tax benefit rule. A payment for damaged or destroyed property is treated as an amount received in a sale or exchange of the property. Thus, the taxpayer has a realized gain if the damages payments received exceed the property's basis. Damages for personal injuries receive special treatment under the Code. In terms of personal injury damages, a distinction is made between compensatory damages and punitive damages. Under specified circumstances, compensatory damages may be excluded from gross income. Under no circumstances may punitive damages be excluded from gross income. 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 otherwise 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 (even though the total benefit received may exceed the premiums paid).

Laura was recently diagnosed with cancer and has begun chemotherapy treatments. A cancer specialist has stated that Laura has less than one year to live. She has incurred a many of medical bills and other general living expenses and is in need of cash. Therefore, she is considering selling stock that cost $35,000 and has a fair market value of $50,000. This amount would be sufficient to pay her medical bills. However, she has read about a company (the Vital Benefits Company) that would purchase her life insurance policy for $50,000. She has paid $30,000 in premiums on the policy. a. Considering the tax effects, complete the statements below regarding the results of selling the stock and the life insurance policy. The sale of the stock by Laura will result in a __________of $________ . The sale of the life insurance policy will result in a _________ gain of $________ .

Answers: a capital gain; $15,000; a nontaxable; $20,000. The sale of the stock by Laura will result in a $15,000 ($50,000 amount realized - $35,000 adjusted basis) capital gain. However, Laura's capital gain rate may be 0% if she is in the 10% or 15% marginal tax brackets. If she is in the 25% or greater marginal tax brackets, her alternative tax rate will be 15%. If she is in the 39.6% marginal tax bracket, her alternative tax rate will be 20%. So, her tax liability on the $15,000 capital gain could be either $3,000 ($15,000 × 20%) or $2,250 ($15,000 × 15%) or $0 ($15,000 × 0%). Generally, if the owner of a life insurance policy cancels the policy and receives the cash surrender value, the taxpayer must recognize gain equal to the excess of the amount received over premiums paid on the policy (a loss is not deductible). The gain is recognized because the general exclusion provision for life insurance proceeds applies only to life insurance proceeds paid upon the death of the insured. If the taxpayer cancels the policy and receives the cash surrender value, the life insurance policy is treated as an investment by the insured. In a limited circumstance, however, the insured is permitted to receive the benefits of the life insurance contract without having to include the gain in gross income. Under the accelerated death benefits provisions, exclusion treatment is available for insured taxpayers who are either terminally ill or chronically ill. A terminally ill taxpayer can collect the cash surrender value of the policy from the insurance company or assign the policy proceeds to a qualified third party. The resultant gain, if any, is excluded from the insured's gross income. Thus, if Laura is diagnosed as "terminally ill," the realized gain on the life insurance policy of $20,000 ($50,000 - $30,000) is excluded from her gross income.

Does the taxpayer recognize gross income in the following situations? a. Ava is a filing clerk at a large insurance company. She is permitted to leave the premises for lunch, but she usually eats in the company's cafeteria because it is quick and she is on a tight schedule. On average, she pays $2 for a lunch that would cost $12 at a restaurant and it cost her employer $10 to prepare. However, if the prices in the cafeteria were not so low and the food was not so delicious, she would probably bring her lunch at a cost of $3 per day. Ava's meals are provided as a convenience for the employee . Therefore, Ava would include $______ per meal in her gross income.

Answers: a convenience for the employee; $10. Section 119 excludes from income the value of meals and lodging provided to the employee and the employee's spouse and dependents under the following conditions: The meals and/or lodging are furnished by the employer on the employer's business premises for the convenience of the employer. In the case of lodging, the employee is required to accept the lodging as a condition of employment. The on the employer's business premises requirement, applicable to both meals and lodging, per the Regulations, define business premises as simply "the place of employment of the employee." The convenience of the employer test is intended to focus on the employer's motivation for furnishing the meals and lodging rather than on the benefits received by the employee. The employee is required to accept test applies only to lodging. If the employee's use of the housing would serve the convenience of the employer but the employee is not required to use the house, the exclusion is not available. The "convenience of the employer" test is intended to focus on the employer's motivation for furnishing the meals rather than on the benefits received by the employee. If the employer furnishes the meals primarily to enable the employee to perform his or her duties properly, then they are excluded. It appears that Ava's meals are not provided for the convenience of the employer, but rather as a fringe benefit for the employees. Therefore, Ava is required to include in gross income the difference between the amount she paid for the meals of $2 and the amount she would be required to pay of $12 to an unrelated restaurant. A comparison to the poorer quality of the self-prepared lunch is not a valid measure of the benefit she actually received.

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. How is the amount received by Amber be treated for tax purposes? The $30,000 is or is not taxable

Answers: is. The income tax treatment of accident and health insurance benefits depends on whether the policy providing the benefits was purchased by the taxpayer or the taxpayer's employer. Benefits collected under an accident and health insurance policy purchased by the taxpayer are excludible. In this case, 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).

Eagle Life Insurance Company pays its employees $.30 per mile for driving their personal automobiles to and from work. The company reimburses each employee who rides the bus $100 a month for the cost of a pass. Tom, in his Mazda 2-seat Roadster, collected $100 for his automobile mileage, and Mason received $100 as reimbursement for the cost of a bus pass. If an amount is zero, enter "0". a. What are the effects of the $100 reimbursement on Tom's and Mason's gross income? Tom ______ and Mason ______ the $100 in gross income (Includes/Excludes)

Tom includes and Mason excludes the $100 in gross income. Answers: includes; excludes. The intent of the exclusion for qualified transportation fringes is to encourage the use of mass transit for commuting to and from work. Qualified transportation fringes encompass the following transportation benefits provided by the employer to the employee: Transportation in a commuter highway vehicle between the employee's residence and the place of employment. A transit pass. Qualified parking. Qualified bicycle commuting reimbursement. Statutory dollar limits are placed on the amount of the exclusion. Categories (1) and (2) above are combined for purposes of applying the limit. For 2017, the inflation adjusted limit for categories (1) and (2) combined, as well as for category (3), is $255 per month. Category (4) [qualified bicycle] 2017 reimbursement is up to $20 per qualified bicycle commuting month. A commuter highway vehicle is any highway vehicle with a seating capacity of at least six adults (excluding the driver). In addition, at least 80% of the vehicle's use must be for transporting employees between their residences and place of employment. Tom's Mazda 2-seat Roadster does not qualify as a commuter highway vehicle. Tom must include the $100 in gross income. Mason is allowed to exclude the $100 as a qualified transportation fringe benefit. The intent of the exclusion for qualified transportation fringe benefits is to encourage the use of mass transit for commuting to and from work. The transit pass would qualify under this exclusion; therefore, the $100 is nontaxable to Mason.

Christie sued her former employer for a back injury she suffered on the job in 2017. As a result of the injury, she was partially disabled. In 2018, she received $240,000 for her loss of future income, $160,000 in punitive damages because of the employer's flagrant disregard for the employee's safety, and $15,000 for medical expenses. The medical expenses were deducted on her 2017 return, reducing her taxable income by $12,000. Christie's 2018 gross income from the above is: a. $172,000. b. $412,000. c. $175,000. d. $255,000. e. $415,000.

a. $172,000. Christie must include in gross income the $160,000 of punitive damages received and the $12,000 for the previously deducted medical expenses. The medical expense recovery is included in gross income under the tax benefit rule.

During the current year, Khalid was in an automobile accident and suffered physical injuries. The accident was caused by Rashad's negligence. Khalid threatened to file a lawsuit against Amber Trucking Company, Rashad's employer, claiming $50,000 for pain and suffering, $90,000 for loss of income, and $70,000 in punitive damages. Amber's insurance company will not pay punitive damages; therefore, Amber has offered to settle the case for $100,000 for pain and suffering, $90,000 for loss of income, and nothing for punitive damages. Khalid is in the 35% marginal tax bracket. What is the after-tax difference to Khalid between Khalid's original claim and Amber's offer? a. Amber's offer is $4,500 more. {$190,000 - ($50,000 + $90,000) + [$70,000 × (1 - .35)]}. b. Amber's offer is $22,000 more. [($190,000 - $210,000) + ($120,000 × .35)]. c. Amber's offer is $20,000 less. ($50,000 + $90,000 + $70,000 - $100,000 - $90,000). d. Amber's offer is $7,000 less. [($50,000 + $90,000 + $70,000 - $100,000 - $90,000) × .35)]. e. None of these choices are correct.

a. Amber's offer is $4,500 more. {$190,000 - ($50,000 + $90,000) + [$70,000 × (1 - .35)]}. Only the punitive damages are taxable. The after-tax proceeds from the amount of punitive damages claimed, (1 - .35) × $70,000 = $45,500.

Calculator Turquoise Company purchased a life insurance policy on the company's chief executive officer, Joe. After the company had paid $400,000 in premiums, Joe died and the company collected the $1.5 million face amount of the policy. The company also purchased group term life insurance on all its employees. Joe had included $16,000 in gross income for the group term life insurance premiums. Joe's widow, Rebecca, received the $100,000 proceeds from the group term life insurance policy. a. Turquoise Company and Rebecca can exclude the life insurance proceeds of $1,500,000 and $100,000, respectively, from gross income. b. Rebecca can exclude the life insurance proceeds of $100,000, but Turquoise Company must include $1,100,000 ($1,500,000 - $400,000) in gross income. c. Turquoise Company can exclude $1,100,000 ($1,500,000 - $400,000) from gross income, but Rebecca must include $84,000 in gross income. d. Turquoise Company must include $1,100,000 ($1,500,000 - $400,000) in gross income and Rebecca must include $100,000 in gross income. e. None of these choices are correct.

a. Turquoise Company and Rebecca can exclude the life insurance proceeds of $1,500,000 and $100,000, respectively, from gross income. All of the proceeds qualify for the life insurance exclusion because the payments were received as a result of the death of the insured.

Calculator Jack received a court award in a civil libel and slander suit against National Gossip. He received $120,000 for damages to his professional reputation, $100,000 for damages to his personal reputation, and $50,000 in punitive damages. Jack must include in his gross income as a damage award: a. $100,000. b. $270,000. c. $120,000. d. $0. e. None of these choices are correct.

b. $270,000. None of the damages received were the result of a physical personal injury or sickness and therefore the total amount received must be included in gross income. Even if the damages were the result of physical personal injury, the punitive damages would be included in his gross income.

Jena is a full-time undergraduate student at State University and is claimed by her parents as a dependent. Her only source of income is a $10,000 athletic scholarship ($1,000 for books, $5,500 tuition, $500 student activity fee, and $3,000 room and board). Jena's gross income for the year is: a. $500. b. $3,000. c. $4,000. d. $10,000. e. None of these choices are correct.

b. $3,000. The portion included in gross income is $3,000 for room and board. The books ($1,000), tuition ($5,500), and student activity fee ($500) qualify for exclusion. The fact that the scholarship is received for athletic, rather than academic, achievement is irrelevant, because the payments are to further the student's education.

Calculator Swan Finance Company, an accrual method taxpayer, requires all of its customers to carry credit life insurance. If a customer dies, the company receives from the insurance company the balance due on the customer's loan. Ali, a customer, died owing Swan $1,500. The balance due included $200 accrued interest that Swan has included in income. When Swan collects $1,500 from the insurance company, Swan: a. Must recognize $1,300 income from the life insurance proceeds. b. Does not recognize income from the life insurance because the entire amount is a recovery of capital. c. Must recognize $1,500 income from the life insurance proceeds. d. Does not recognize income because life insurance proceeds are tax-exempt. e. None of these choices are correct.

b. Does not recognize income from the life insurance because the entire amount is a recovery of capital. Swan has a basis in the receivable of $1,500, since it is an accrual method taxpayer.

Iris collected $150,000 on her deceased husband's life insurance policy. The policy was purchased by the husband's employer under a group policy. Iris's husband had included $5,000 in gross income from the group term life insurance premiums during the years he worked for the employer. She elected to collect the policy in 10 equal annual payments of $18,000 each. a. The amount she receives in the first year is a nontaxable return of capital. b. For each $18,000 payment that Iris receives, she can exclude $15,000 ($150,000/$180,000 × $18,000) from gross income. c. For each $18,000 payment that Iris receives, she can exclude $500 ($5,000/$180,000 × $18,000) from gross income. d. None of the payments must be included in Iris's gross income. e. None of these choices are correct.

b. For each $18,000 payment that Iris receives, she can exclude $15,000 ($150,000/$180,000 × $18,000) from gross income. The life insurance proceeds of $150,000 are excluded from Iris's gross income. The income portion of each annuity payment is $3,000 ($18,000 - $15,000 recovery of capital). The recovery of capital of each annuity payment is $15,000 [($150,000/$180,000) × $18,000].

Ben was diagnosed with a terminal illness. His physician estimated that Ben would live no more than 18 months. After he received the doctor's diagnosis, Ben cashed in his life insurance policy and used the proceeds to take a trip to see relatives and friends before he died. Ben had paid $12,000 in premiums on the policy, and he collected $50,000, the cash surrender value of the policy. Henry enjoys excellent health, but he cashed in his life insurance policy to purchase a new home. He had paid premiums of $12,000 and collected $50,000 from the insurance company. a. Neither Ben nor Henry is required to recognize gross income. b. Henry must recognize $38,000 ($50,000 - $12,000) of gross income, but Ben does not recognize any gross income. c. Ben must recognize $38,000 ($50,000 - $12,000) of gross income, but Henry does not recognize any gross income. d. Both Ben and Henry must recognize $38,000 ($50,000 - $12,000) of gross income. e. None of these choices are correct.

b. Henry must recognize $38,000 ($50,000 - $12,000) of gross income, but Ben does not recognize any gross income. The redemption of the policy by Ben qualifies as an accelerated death benefit paid to a terminally ill policy holder. The exclusion applies regardless of how the insurance proceeds are used. Thus, the realized gain of $38,000 is excluded from Ben's gross income.

Ron, age 19, is a full-time graduate student at City University. During 2017, he received the following payments: Cash award for being the outstanding resident adviser $ 1,500 Resident adviser housing 2,500 State scholarship for ten months (tuition and books) 6,000 State scholarship (meals allowance) 2,400 Loan from college financial aid office 3,000 Cash support from parents 2,000 $17,400 Ron served as a resident adviser in a dormitory and, therefore, the university waived the $2,500 charge for the room he occupied. What is Ron's adjusted gross income for 2017? a. $9,000. b. $1,500. c. $3,900. d. $15,400. e. None of these choices are correct.

c. $3,900. The $1,500 award for being the outstanding resident adviser is included in Ron's gross income. The $2,400 meal allowance must also be included in Ron's gross income. The $2,500 waiver for housing is not included in Ron's gross income because the housing is provided for the convenience of his employer. The $6,000 scholarship for tuition and books is excluded from his gross income. The loan of $3,000 is not income.

Theresa sued her former employer for age, race, and gender discrimination. She claimed $200,000 in damages for loss of income, $300,000 for emotional harm, and $500,000 in punitive damages. She settled the claim for $700,000. As a result of the settlement, Theresa must include in gross income: a. $500,000. b. $490,000 [($700,000/$1,000,000) × $700,000]. c. $700,000. d. $0. e. None of these choices are correct.

c. $700,000. The damages did not arise out of a physical personal injury; therefore, none of the amount received can be excluded from gross income.

Albert had a terminal illness which required almost constant nursing care for the remaining two years of his estimated life, according to his doctor. Albert had a life insurance policy with a face amount of $100,000. Albert had paid $25,000 of premiums on the policy. The insurance company has offered to pay him $80,000 to cancel the policy, although its cash surrender value was only $55,000. Albert accepted the $80,000. Albert used $15,000 to pay his medical expenses. Albert made a miraculous recovery and lived another 20 years. As a result of cashing in the policy: a. Albert must recognize $40,000 ($80,000 - $25,000 - $15,000) of gross income. b. Albert must recognize $55,000 of gross income, but he has $15,000 of deductible medical expenses. c. Albert is not required to recognize any gross income because of his terminal illness. d. Albert must recognize $65,000 ($80,000 - $15,000) of gross income. e. None of these choices are correct.

c. Albert is not required to recognize any gross income because of his terminal illness. Albert's realized gain is $55,000 ($80,000 - $25,000). However, Albert was terminally ill and, therefore, can qualify for the accelerated death benefit exclusion for his life insurance policy.

Calculator Cash received by an employee from an employer: a. Is not taxable unless the payor is legally obligated to make the payment. b. Must always be included in gross income. c. May be included in gross income although the payor is not legally obligated to make the payment. d. Is not included in gross income if it was not earned. e. None of these choices are correct.

c. May be included in gross income although the payor is not legally obligated to make the payment.

The taxpayer is a Ph.D. student in accounting at City University. The student is paid $1,500 per month for teaching two classes. The total amount received for the year is $13,500. a. The $13,500 is excludable if the money is used to pay for tuition and books. b. The $13,500 is excluded because the total amount received for the year is less than her standard deduction and personal exemption. c. The $13,500 is taxable compensation. d. The $13,500 is considered a scholarship and, therefore, is excluded. e. None of these choices are correct.

c. The $13,500 is taxable compensation. The $13,500 represents compensation for services rendered and must be included in the student's gross income.

Sharon had some insider information about a corporate takeover. She unintentionally informed a friend, who immediately bought the stock in the target corporation. The takeover occurred and the friend made a substantial profit from buying and selling the stock. The friend told Sharon about his stock dealings, and gave her a pearl necklace because she "made it all possible". The necklace was worth $10,000, but she already owned more jewelry than she desired. a. The value of the necklace is not included in Sharon's gross income because passing the information was an illegal act and the SEC can confiscate the necklace. b. The necklace is a nontaxable gift received by Sharon because the friend was not legally required to make the gift. c. The value of the necklace must be included in Sharon's gross income for the tax year it was received by her. d. The value of the necklace is not included in Sharon's gross income unless she sells it. e. None of these choices are correct.

c. The value of the necklace must be included in Sharon's gross income for the tax year it was received by her. The necklace Sharon received from her friend was compensation for the information, rather than an amount received out of detached generosity. The fact the friend was not legally obligated to make the payment does not affect the outcome in this case.

Calculator A scholarship recipient at State University may exclude from gross income the scholarship proceeds used to pay for: a. Tuition, books, supplies, meals, and lodging. b. Meals and lodging. c. Tuition, books, and supplies. d. Only tuition. e. None of these choices are correct.

c. Tuition, books, and supplies.

Calculator Carin, a widow, elected to receive the proceeds of a $150,000 life insurance policy on the life of her deceased husband in 10 installments of $17,500 each. Her husband had paid premiums of $60,000 on the policy. In the first year, Carin collected $17,500 from the insurance company. She must include in gross income: a. $10,000. b. $25,000. c. $2,500. d. $0. e. None of these choices are correct.

c.$2,500 The interest element of $25,000 ($175,000 - $150,000) is included in Carin's gross income. The payments are taxed as an annuity, and therefore $2,500 [($25,000/$175,000) × $17,500] is included in Carin's gross income in the first year.

The taxpayer's marginal tax bracket is 25%. Which would the taxpayer prefer? a. $1.25 taxable income rather than $1.00 tax-exempt income. b. $1.00 taxable income rather than $.75 tax-exempt income. c. $1.00 taxable income rather than $1.25 tax-exempt income. d. $1.40 taxable income rather than $1.00 tax-exempt income. e. None of these choices are correct.

d. $1.40 taxable income rather than $1.00 tax-exempt income. The $1.40 of taxable income is greater after-tax than $1.00 in taxable income [(1 - .25)($1.40) = $1.05]. "$1.00 taxable income rather than $.75 tax-exempt income" is incorrect because the $1.00 of taxable income and $.75 of tax-exempt income are equal on an after-tax basis (1 - .25) × $1.00 = $.75. "$1.25 taxable income rather than $1.00 tax-exempt income" is incorrect because (1 - .25) × $1.25 = $.9375.

Hide or show questions Calculator Barney is a full-time graduate student at State University. He serves as a teaching assistant for which he is paid $700 per month for 9 months and his $5,000 tuition is waived. The university waives tuition for all of its employees. In addition, he receives a $1,500 research grant to pursue his own research and studies. Barney's gross income from the above is: a. $0. b. $12,800. c. $11,300. d. $6,300. e. None of these choices are correct.

d. $6,300. The monthly stipend of $700 (for 9 months = $6,300) for teaching is taxable compensation. The research grant of $1,500 is to assist him in his education and is not in exchange for services; therefore, the grant is a nontaxable scholarship. The tuition waiver is excluded as a qualified tuition reduction program.

As an executive of Cherry, Inc., Ollie receives a fringe benefit in the form of annual tuition scholarships of $10,000 to each of his three children. The scholarships are paid by the company on behalf of the children of key employees directly to each child's educational institution and are payable only if the student maintains a B average. a. The tuition payments of $10,000 each must be included in the child's gross income. b. The tuition payments of $30,000 may be excluded from Ollie's gross income as a scholarship. c. The tuition payments of $30,000 may be excluded from Ollie's gross income because the payments are for the academic achievements of the children. d. The tuition payments of $30,000 must be included in Ollie's gross income. e. None of these choices are correct.

d. The tuition payments of $30,000 must be included in Ollie's gross income. The tuition payments of $30,000 are compensation to Ollie since the awards are only to children of key employees.

Early in the year, Marion was in an automobile accident during the course of his employment. As a result of the physical injuries he sustained, he received the following payments during the year: Reimbursement of medical expenses Marion paid by a medical insurance policy he purchased $10,000 Damage settlement to replace his lost salary 15,000 What is the amount that Marion must include in gross income for the current year? a. $10,000. b. $12,500. c. $15,000. d. $25,000. e. $0.

e. $0. The medical expenses of $10,000 that were reimbursed by Marion's medical insurance policy can be excluded from gross income. The $15,000 Marion received for the physical personal injury damage settlement can be excluded from gross income even though the payment replaces his salary.