ACTG421 Chapters 3, 4, 5, 6

Determine the amount of income that must be recognized: Fatima is named Humanitarian of the Year by Local City for her volunteer service. She receives a plaque and an all-expense-paid trip to Washington, D. C., where she will meet the president. The value of the trip is $1,400. Assume that Fatima does not transfer her award to a charitable or governmental organization.

$1,400

Determine the amount of income that must be recognized: Sook is a college professor specializing in computer chip development. During the current year, he publishes a paper that explains the design of a revolutionary new chip. Softmicro, Inc., awards him $10,000 for the best breakthrough idea of the year. Sook uses the money to purchase a computer workstation to use in his research.

$10,000

Devi is the chief executive officer of Nishida Limited. Devi owns 20% of the common stock of Nishida. During the current year, Devi's salary is $60,000 and he receives a $30,000 bonus. Nishida has taxable income of $200,000 and pays $80,000 in cash dividends. How much gross income does Devi have if Nishida is a regular corporation? If Nishida is an S corporation?

$106,000; $130,000 Regular corporation - A corporation is a taxable entity responsible for payment of tax on its own income. Shareholders receive income in the form of dividends. Devi's gross income consists of his salary, bonus, and his receipt of cash dividends. Devi's dividend is $16,000 ($80,000 x 20%), making his gross income $106,000 ($60,000 + $30,000 + $16,000) S corporation - An S corporation is a conduit entity that reports its income to the government, but does not pay tax on the income. Each shareholder must report his or her proportionate share of the S corporation's taxable income on their tax return. Shareholders can be employees of corporations, so Devi is taxed on the $90,000 ($60,000 + $30,000) of salary and bonus he receives. He must also include his share of Nishida's income, $40,000

Geraldo is a sales manager who enjoys collecting antique guns. Geraldo attends various shows around the country at which collectors and dealers sell and trade guns. During the current year, Geraldo sells 3 guns for a total of $6,200 (the cost of the guns to Geraldo was $4,000) and purchases 2 guns at a total cost of $2,400. In addition, he exchanges a gun for which he had paid $700 for another gun worth $800. Geraldo has ________ of income from the sale of the 3 guns. He also has _______ of income from the gun exchange. The exchange of guns constitutes a realization—his wealth has ________ in an arm's-length transaction. All income received is _______.

$2,200; $100; increased; taxable

Determine the amount of income that must be recognized: Ramona is a production supervisor for White Company. During the current year, her division had no accidents, and White rewarded the achievement with a $200 cash award to each employee in the division.

$200

Manu gives hula lessons at a local bar. During the current year, she receives $9,000 in salary and $8,000 in tips. In addition, she engages in illegal behavior, for which she receives $10,000. Manu has to report _______ of taxable income.

$27,000

During the year, Grace, Inc., has total sales of $800,000. Based on total sales, the corporation estimates that its bad debts for the year are 2% of sales. As a result, the corporation deducts $16,000 in bad debts for financial accounting purposes. At the end of the year, the controller reviews the accounts receivable ledger to identify uncollectible accounts. She determines that $3,900 in accounts receivable cannot be collected. In addition, the accountant's analysis shows that the corporation has recovered $1,400 in accounts receivable written off as a bad debt for tax purposes in the previous year. Using the specific charge-off method results in a ____ business bad debt deduction in the current year. The recovery of the _____ of bad debts deducted in the previous year ____ reported as income in the current year under the tax benefit rule.

$3,900; $1,400; must be

On May 1, Raisa received a $10,000, 9% bond of Altomba Corporation as a graduation present from her Aunt Lenia. The bond pays interest on June 30 and December 31. What are the tax effects of this transfer for Raisa and Lenia for the current year? Lenia is taxed on the ____ of interest earned up to the date of the gift. Raisa must recognize ____ of interest from the June 30 payment and the entire _____ December 31 payment, a total of ______ of interest income for the year.

$300; $150; $450; $600

Kimo builds custom surfboards. During the current year, his total revenues are $90,000, and he incurs $30,000 in expenses. Included in the $30,000 is a $10,000 payment to Kimo's five-year-old son for services as an assistant. Kimo has to report _______ of taxable income from the custom surfboard business on his personal tax return.

$70,000

A.J. is the vice president for Keane Products, a marketing consulting firm. On a business trip to New York City in 2018, he meets with three executives from Keane's top account. After the meeting, A.J. takes them to dinner and then to the theater. The theater tickets cost $350. The cost of the meal is $190, including sales tax of $17 and a tip of $34. Throughout the evening, A.J. pays $42 in cab fares.

A.J. can deduct $95 (50% x $190) for the meal. The entertainment, although related to a trade or business, is not deductible because the Tax Cut and Jobs Act disallows a deduction for entertainment expenses after December 31, 2017. The $42 cab fare is fully deductible as transportation and is not subject to the 50% rule because it is not considered to be an entertainment expense. Thus, A.J's total deduction for the evening is $137 (95 + $42)

Do Pat and Tuck recognize income in the following situation? Pat Corporation owns a gourmet restaurant. The restaurant needs to remodel its kitchen but is short of cash. Dennis owns Tuck's Accessories, a restaurant supply store. The manager of Pat makes a deal with Dennis to have Tuck's do the kitchen remodeling, in exchange for which Pat will cater Tuck's company picnic. Tuck's does the remodeling and Pat caters the picnic. It costs Pat $800 to cater the picnic, a job for which it would have charged $1,500.

All income received is taxable (all-inclusive income concept). Income can be received in any form. Both Patz and Tuck have received something of value in exchange for their services. Patz receives remodeling in exchange for catering services worth $1,500 and must recognize $1,500 of income from catering. Tuck's Accessories receives catering worth $1,500 in exchange for the remodeling job and must recognize $1,500 of income from remodeling.

What is an installment sale?

An installment sale is any sale of property at a gain in which payments are received in more than one tax year. Qualifying taxpayers must use the installment sales method to recognize income from the sale. They may make an election to recognize the entire gain in the period of sale).

Hector and Nicole are retired. During the current year, they receive $11,000 from a qualified pension plan, $3,000 of dividends on common stock holdings, $6,000 of tax-exempt interest, and $10,000 of Social Security benefits. Hector and Nicole's adjusted gross income is: A) $14,000 B) $19,000 C) $24,000 D) $30,000

Answer: A Explanation: $14,000 ($11,000 pension + $3,000 dividends) The base amount for the 50 percent formula for a married couple filing jointly is $32,000. The pension $11,000 + dividends $3,000 + tax exempt interest 6,000 + 50% of social security $5,000 is below the base amount. Since the amount is below the base amount, nothing needs to be included in their adjusted gross income.

Ona is a retired schoolteacher who receives a pension of $800 per month (Ona made no payments into the pension plan) and $2,000 of Social Security benefits per month. Ona's adjusted gross income is: A) $9,600 B) $13,900 C) $21,900 D) $24,000 E) $33,600

Answer: A Explanation: $9,600 ($800 x 12) The base amount for the 50 percent formula for a single individual is $25,000. Her pension of $9,600 ($800 x 12) and half her social security (50% of 12 x $2,000) is below the base amount. Therefore she does not need to include ½ of the social security in her adjusted gross income.

Bill is a university professor. He has set aside one room in his home exclusively as a home office where he grades papers, prepares for class, etc. No revenues are generated from her activities. Depreciation and maintenance are $800 on the home office space. How much of the expenses are deductible by Bill? A) $0B) $200C) $400D) $500E) $800

Answer: A Explanation: None of the cost is deductible. The expense is not for the convenience of Bill's employer.

Which of the following legal expenses paid by the Kerr Corporation can be deducted in the current year? Legal fees incurred in a tax dispute with the IRS. Legal fees to purchase land which will be used to expand its warehouse. Only statement I is correct. Only statement II is correct. Both statements are correct. Neither statement is correct.

Answer: A Explanation: Only statement I is correct. I. Legal fees incurred in a tax dispute with the IRS are deductible. Legal fees incurred to purchase land which will be used to expand the warehouse must be capitalized.

Which of the following taxes paid by the Fowlers Company can be deducted during 2018? State sales tax paid on utilities. Federal income paid when Fowlers files its 2017 tax return. A) Only statement I is correct. B) Only statement II is correct. C) Both Statements are correct. D) Neither statement is correct.

Answer: A Explanation: Only statement I is correct. I. State sales tax paid on utilities are deductible. Federal income tax is not deductible.

Pedro owns 5 rental properties. He contracts with East Lake Properties, Inc., to manage the real estate. East Lake obtains tenants, negotiates leases, makes necessary repairs, pays expenses related to the properties, and remits monthly net receipts to Pedro. Pedro's sale at a gain will result in capital gain Pedro's sale at a loss will result in ordinary loss A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answer: A Explanation: Only statement I is correct. Pedro's activity is not sufficient to be a trade or business. I. Pedro's sale at a gain will result in capital gain

All of the following are a required test for the deduction of a business expense except? A) GAAP approved. B) Ordinary. C) Necessary. D) Business purposes. E) Reasonable in amount.

Answer: A Explanation: The expenditure does not need to be GAAP approved.

Conzo is injured in an accident while working at his job. He received $1,500 in worker's compensation benefits for 5 weeks of lost work. How much should Conzo report as gross income from the receipt of these benefits? A) $0B) $300C) $750D) $900E) $1,500

Answer: A - $0 Explanation: Workmen's compensation benefits are not taxable.

Hector's current annual salary is $50,000. Hector's employer has a qualified pension plan to which it contributes 6% of his gross salary (e.g., $3,000). The pension plan also earns $2,500 during the current year on contributions made to the plan on behalf of Hector. What is Hector's gross income from these transactions for the current year? A) $50,000B) $52,500C) $53,000D) $55,500

Answer: A - $50,000 Explanation: While Hector's economic wealth went up to $55,500 ($50,000 + $3,000 + $2,500), Hector is not taxed on his employer's contribution to the pension plan or on the income earned on his share of pension plan earnings. This example illustrates the tax benefits to an employee of a pension plan.

Arlene, a criminal defense attorney inherits $500,000 from her grandmother. Unsure of how to invest the money, Arlene attends a 3-day investment seminar in New York. Arlene attends all the sessions and receives a certificate for successfully completing the seminar. Her expenses to attend the seminar are as follows: Airfare $450 Hotel daily rate 110 a day Meals at 40 a day Incidentals 15 a day Entertainment 140 What amount may Arlene deduct? A) $0 B) $780 C) $825 D) $885 E) $955

Answer: A -$0 Explanation: The investment activity is not a trade or business. The connection to production of income is remote.

Nora, a single individual age 60, receives a gold watch worth $700 during her retirement luncheon, based upon her long tenure with the company. The company does not have a formal plan. How much of the award must Nora recognize in her gross income for the current year? A) $0 B) $300 C) $400 D) $500 E) $700

Answer: B Explanation: $300 since the company does not have a plan ($700 - $400) If the company has a formal plan, up to $1,600 could be excluded.

Which of the following is/are trade or business expenses? I. Sally incurs legal expenses related to real estate he leases to Bucko Burger Hamburger Haven for a parking lot. Sally does little but negotiate the lease every year. II. Susan owns several rental apartments. She negotiates new rental contracts, arranges for repairs and maintenance, and handles all leasing activities. A) Only Statement I is correct. B) Only Statement II is correct. C) Both Statements are correct. D) Neither Statement is correct.

Answer: B Explanation: Only Statement II is correct. II. Susan owns several rental apartments. She negotiates new rental contracts, arranges for repairs and maintenance, and handles all leasing activities.

Which of the following taxpayers can claim a business bad debt deduction for the current year? I. Johnson is a dentist using the cash basis of accounting. He has accounts receivable from patients totaling $7,800 that are more than 90 days past due. II. George owns and operates a sporting goods store and uses the accrual method of accounting. He has several customers who have owed him money for more than 10 months. A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answer: B Explanation: Only statement II is correct. II. George owns and operates a sporting goods store and uses the accrual method of accounting. He has several customers who have owed him money for more than 10 months. Cash basis taxpayers have not taken accounts receivable into income; they therefore can not claim a bad debt deduction.

Ally served as chairperson of the local school board. Upon completion of her term in office, the employees in the school district offices take up a collection and purchase her a silver sterling tray in recognition of her outstanding service to the organization. The value of the tray is $200. What are the tax effects of the award? I. The value of the tray is included in gross income because of services rendered. II. The tray is a gift because it is from a detached and disinterested generosity. A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answer: B Explanation: Only statement II is correct. II. The tray is a gift because it is from a detached and disinterested generosity.

Stephen is a furniture salesman for Foster's Furniture Mart. Stephen purchases a bedroom suite from Foster's for $8,000. The sticker price is $11,000. Foster's policy is to "discount" all customer purchases for up to $1,000 off of the sticker price for purchases over $10,000. What is the tax treatment of Stephen's furniture purchase? Stephen does not need to account for the furniture purchase since it is for his personal use. Stephen has imputed income because of the nature of the furniture purchase. a. Only statement I is correct. b. Only statement II is correct. c. Both statements are correct. d. Neither statement is correct.

Answer: B Explanation: Only statement II is correct. Stephen has imputed income because of the nature of the furniture purchase. The amount of imputed income is $2,000. The difference between the discounted price of $10,000 and the price Stephen paid ($8,000).

Alexis Corporation allows an employee, Cynthia, to use a company car for her vacation to San Diego. Cynthia will not need to recognize the value of the use of the car since it was not cash. A "cash equivalent approach" is used to measure the amount of income that Cynthia must recognize. A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answer: B Explanation: Only statement II. is correct. II. A "cash equivalent approach" is used to measure the amount of income that Cynthia must recognize.

Ward and June are in the 28% tax bracket. Included in their assets is a Dell Corporation bond with a face value of $10,000. The bond pays $1,000 per year in interest. Ward and June gift the bond to their son, Wally (age 19), on January 1. Wally is in the 10% tax bracket. Wally's taxable income from the receipt of the bond and the bond interest for the year A) $0 B) $1,000 C) $1,500 D) $10,000 E) $11,000

Answer: B - $1,000 Explanation: The gift of the bond is excluded from gross income. The $1,000 interest on the bonds is gross income to Wally.

Samuel slips on an icy spot in front of an apartment and is hospitalized for three weeks. The owner of the apartment pays Samuel's $14,000 medical expenses and gives him $4,000 for his pain and suffering. Samuel receives his regular $1,800 salary from his employer while he couldn't work and also receives $7,000 in disability pay from a plan that he had purchased. Samuel's gross income from these payments is: A) $0B) $1,800C) $2,500D) $5,800E) $8,800

Answer: B - $1,800 Explanation: Medical payments and payments for pain and suffering are excluded as damages. Regular salary payment from his employer are not excluded. Since Samuel paid for the disability policy, the amount received under the policy is excluded from income.

Jerry's wife dies in September. His wife had paid $20,000 of premiums on a $150,000 face value whole life insurance policy. Jerry elects to receive the life insurance policy proceeds in 20 annual installments of $10,000. Jerry receives his first $10,000 payment this year. How much of the payment should Jerry report as gross income? A) $0B) $2,500C) $5,000D) $7,500E) $10,000

Answer: B - $2,500 Explanation: Total payments 10 x $20,000 = $200,000 Face value of Policy $150,000 (excluded from gross income) Excess taxable 50,000 Ratio 50,000 / 200,000 25% Payment $10,000 x 25% = $2,500

On April 1, Sally is given $20,000 worth of General Motors bonds for her 18th birthday. On June 30, Sally receives the $800 annual interest payment on the bonds. How much income should Sally recognize due to these two events? A) $0 B) $200 C) $800 D) $20,000 E) $20,000

Answer: B - $200 Explanation: The $20,000 gift is excluded from income. Of the $800 interest, Sally is only taxable on the interest earned after she received the gift. The interest accrues at $66.66 a month. $800 / 12 = $66.66 interest a month Since Sally owned the bonds for 3 months, she has to report $200 interest 3 months @ $66.66 a month = $200

Chip, a single individual has 2 sales of stock during the current year. The first sale produces a short-term loss of $10,000 and the second sale results in a long-term gain of $40,000. Chip's taxable income without considering the gain is $150,000. Chip's stock transactions will increase his income tax liability by: A) $3,200 B) $4,500 C) $6,000 D) $8,000 E) $8,400

Answer: B - $4,500 Explanation: The short-term loss and the long-term gain are netted. $40,000 - $10,000 = $30,000 Long Term Capital Gain Chip's tax rate on capital gains is 15% in view of his taxable income. $30,000 @ 15% = $4,500

Which of the following requirements does not have to be met for a business or investment expense to be deductible: A) Be ordinary and necessary. B) Be reasonable in amount. C) Be recurring. D) Be the taxpayer's own expense. E) All the above must be met.

Answer: C Explanation: An expenditure does not need to be recurring to be deductible.

A business expense includes I. An expenditure that satisfies the dominant profit-motive requirement II. Expenditures that are incurred in a trade or business activity A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answer: C Explanation: Both statements are correct. I. An expenditure that satisfies the dominant profit-motive requirement II. Expenditures that are incurred in a trade or business activity

Gary won the Nobel Prize in Economics. He receives $1.2 million from the Royal Academy of Sciences in Stockholm. Does he have taxable income from this award? I. If he keeps the prize money, he must include the award in gross income. II. If he tells the Academy to contribute the award to a charitable organization, the amount of the award is excludable from gross income. A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answer: C Explanation: Both statements are correct. I. If he keeps the prize money, he must include the award in gross income. II. If he tells the Academy to contribute the award to a charitable organization, the amount of the award is excludable from gross income.

Frank and Lilly are negotiating a divorce settlement in a year before 1/1/2019. Frank has offered to pay Lilly $12,000 each year for 10 years, but payments cease upon Lilly's death. What are the tax implications of this proposition? I. Lilly must recognize Gross Income when the money is received. II. Frank has a deduction for Adjusted Gross Income in the year of payment. A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answer: C Explanation: Both statements are correct. I. Lilly must recognize Gross Income when the money is received. II. Frank has a deduction for Adjusted Gross Income in the year of payment.

Hilda, age 11, earns wages of $2,700 from her modeling. Since the funds are collected by Hilda's father and used for Hilda's living expenses, her father intends to include it in his gross income. I. The Assignment of Income Doctrine prohibits the father from recognizing the $2,700. II. Even if Hilda desired to gift the $2,700 to her father, Hilda must recognize the income she earned. A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct D) Neither statement is correct.

Answer: C Explanation: Both statements are correct. I. The Assignment of Income Doctrine prohibits the father from recognizing the $2,700. II. Even if Hilda desired to gift the $2,700 to her father, Hilda must recognize the income she earned.

Income tax accounting methods and financial accounting methods differ in many ways. Which of the following tax law provisions are likely to create permanent differences between taxable income and financial (or book) income of a single entity? I. Treatment of payment of penalties and fines. II. Disallowance of 50% of the cost of meals. A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answer: C Explanation: Both statements are correct. I. Treatment of payment of penalties and fines. II. Disallowance of 50% of the cost of meals.

Auto, travel, and gift expenses are subject to strict documentation requirements. Taxpayers are required to keep records that show I. The business purpose of the event. II. The time and place of the event. A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answer: C Explanation: Both statements are correct. The documentation must show: I. The business purpose of the event. II. The time and place of the event.

Maria is on a "full ride" tennis scholarship at Western University. Her $12,500 scholarship covers tuition and books ($7,000) and room and board ($5,500). Maria's gross income is A) $0 B) $2,000 C) $5,500 D) $7,000 E) $12,500

Answer: C - $5,500 Explanation: The scholarship for tuition and books are excluded as scholarships. The room and board are not qualified scholarships.

After negotiating a new supply contract with Jim, Beth takes him to dinner at the Magnolia Cafe. The dinner costs $94. The amount includes tip ($15) and sales tax ($5). Cab fare to and from the restaurant is $20. How much can Beth deduct for the evening's expenditures? A) $47 B) $52 C) $67 D) $94 E) $114

Answer: C - $67 Explanation: The $20 Cab Fare is deductible. Only 50% of the cost of the dinner is deductible $47 = 50% of the cost of the dinner. $47 + $42 = $67

Charlotte traveled to Annapolis to attend a 3-day business conference. After her meetings concluded, she stays 2 additional days sightseeing. Charlotte's airfare is $400 and pays $110 per night for lodging, $60 a day for meals, and $20 a day for incidentals. How much of Charlotte's costs can be deducted as a business expense? A) $0 B) $400 C) $880 D) $ 970 E) $1,200

Answer: C - $880 Explanation: $400 Airfare $330 Hotel - 3 days at $110 $ 60 Incidentals - 3 days at $20 $ 90 Meals - 50% (3 days at $60)

Which of the following best describes the tax treatment of losses from uncollectible business debts? A) Such losses are not deductible.B) Such losses are limited to $3,000 a year. C) Such losses are treated as short term capital loss.D) Such losses are deductible without limit as an ordinary loss.

Answer: D Explanation: D) Such losses are deductible without limit as an ordinary loss. Section 166 Nonbusiness bad debts are deductible as a short-term capital loss. If an individual taxpayer has no capital gain, a capital loss is limited to $3,000.

Which of the following can be deducted as a trade or business expense? A) Lobbying expenses to influence taxpayers. B) Political expenses to elect a local Congressman. C) Illegal bribes to government. D) Rent paid on an office to run an illegal gambling business. E) None of the above can be deducted.

Answer: D Explanation: If the illegal income is reported, the expenses incurred are deductible. There is an exception under Section 280E for expenses related to marijuana.

Which of the following payments are currently deductible? Steve is a self-employed attorney. He pays another attorney $14,000 to represent him in a lawsuit that alleged that he was liable in a personal auto accident Connie has an investment portfolio in excess of $600,000. She pays Chris $1,000 to do an analysis of her investments and make recommendations on restructuring the portfolio A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answer: D Explanation: Neither statement is correct. The lawyer's fees are a personal expense. The TCJA eliminated the miscellaneous itemized deduction for investment related expenses.

Sonya and Butch divorce during in year before 1/1/2019. Their divorce agreement requires Sonya to pay Butch alimony of $2,500 monthly. When their son, Bubba, attains the earliest of either the age 23 or graduates from college, the payments will cease. I. Butch must recognize gross income of $2,500 monthly. II. Sonya may deduct $2,500 monthly from her gross income. III. Butch will not recognize any gross income from the payments. A) Only statements I and II are correct. B) Only statement I is correct. C) Only statement II is correct. D) Only statement III is correct.

Answer: D Explanation: Only statement III is correct. III. Butch will not recognize any gross income from the payments. The payment appears to be child support and not alimony. The payment of child support has no tax effect on the payor or the recipient.

Which of the following constitutes a realization? I. Jamie prepares a will for Wilson. He pays her by painting her house. II. Jones' cow gives birth. The calf will become a member of Jones' cattle herd. III. Oak Ridge Coal Company's coal mine reserves were recently appraised at $5,750,000 more than the previous year's appraisal. IV. Lea's employer gives her (and all other salaried employees) a weekend in Orlando in recognition of their efforts to make this a successful year. A) Only statement I is correct. B) Only statement II is correct. C) Only statements I and II are correct. D) Only statements I and IV are correct. E) Only statements II, III, and IV are correct.

Answer: D Explanation: Only statements I and IV are correct. I. Jamie prepares a will for Wilson. He pays her by painting her house. IV. Lea's employer gives her (and all other salaried employees) a weekend in Orlando in recognition of their efforts to make this a successful year.

Gary receives $40,000 worth of Quantro, Inc., common stock from the estate of his late grandmother. He receives a $100 cash dividend six months later. Before the end of the year, Gary sells the stock for $42,000. Due to these events, how much must Gary include in his gross income for the year? A) $0 B) $100 C) $200 D) $2,100 E) $21,100

Answer: D - $2,100 ($100 dividend + $2,000 capital gain). Explanation: The value of inherited stock is excluded from gross income. The $100 dividend is included in gross income. The $2,000 gain from the sale of stock ($42,000 less $40,000) is include in gross income.

Victor receives a $4,000 per year scholarship from Southern College. The college specifies that $2,500 is for tuition, books, supplies, and equipment for classes. The other $1,500 is for room and board. As part of the conditions of the scholarship, Victor must also work ten hours per week as a grader, for which he is paid $1,700 for the year. Of the total amount received, Victor will include in income: A) $1,500 B) $1,700 C) $2,500 D) $3,200 E) $5,700

Answer: D - $3,200 ($1,500 + $1,700) Explanation: A qualified scholarship can only be for tuition, books and supplies. A scholarship for room and board is not a qualified scholarship. The compensation for grading is taxable compensation.

Sundown, Inc., purchases a term life insurance plan only for its corporate officers. Harold receives $250,000 of insurance at a cost to the company of $3,500. The IRS Table of Premium value indicates that premiums are $1.08 annually per $1,000 of protection. How much gross income does Harold have from the purchase of the life insurance by Sundown, Inc.? A) $216 B) $270 C) $2,800 D) $3,500 E) $5,000

Answer: D - $3,500 Explanation: The plan discriminates in favor of high-ranking employees. Therefore the full cost of the insurance must be included in Harold's income.

Gordon's family health insurance costs $6,000 annually. Gordon and his wife are in the 28% marginal tax rate bracket. His employer offers a cafeteria plan that would allow him to cover the insurance premium. How much would the insurance coverage effectively cost if he took advantage of his employer's cafeteria plan? A) $1,680 B) $3,000 C) $4,320 D) $5,000

Answer: D - $4,320 Explanation: Health Insurance Premium $6,000 Tax Savings at 28% 1,680 After tax cost = 4,320

Ramona's employer pays 100% of the cost of all employees' group-term life insurance. The life insurance plan is not discriminatory. Ramona's annual salary is $100,000. What is the maximum amount of coverage that can be provided tax-free? A) $0 B) $5,000 C) $10,000 D) $50,000 E) $100,000

Answer: D - $50,000 Explanation: The cost of $50,000 of group term life insurance can be excluded from gross income provided that the plan does not discriminate in favor of high ranked employees. The imputed income for the excess $50,000 of group term life insurance will be determined by tables calculated by the IRS.

Ramon is a waiter at Trucker's Delight Restaurant. He eats 2 meals each day at the restaurant at no charge. One is eaten just before he begins work; the other is eaten during working hours. The value of meals consumed by Ramon during the current year is $2,500, evenly distributed between the 2 meals. What are the tax effects of this situation? Ramon will have to recognize $1,250 of income. None are taxable because the meals are for the convenience of the employer. If Ramon has the option of receiving his choice of either a cash payment or the two meals, the $2,500 is taxable. Only statement I is correct. B) Only statement II is correct. C) Only statement III is correct. D) Statements I and II are correct. E) Statements I and III are correct.

Answer: E - $1,250 Explanation: Statements I and III are correct. I. Ramon will have to recognize $1,250 of income. III. If Ramon has the option of receiving his choice of either a cash payment or the two meals, the $2,500 is taxable.

Hector is a 54-year-old head of household and a self-employed taxpayer. He contributed the maximum amount to his IRA account during the current year, and his net earnings from his business totaled $36,000. How much can Hector deduct for AGI in 2019? A) $3,200 B) $3,800 C) $5,500 D) $6,500 E) $7,000

Answer: E - $7,000 Explanation: The normal deductible amount is $6,000. An individual over the age of 50 can deduct an additional $1,000.

The Business Purpose Concept means I. That the economic purpose of the transaction must exceed the tax avoidance motive. II. That the taxpayer's dominant motive for an expenditure is to reduce taxation. A) Only statement I is correct. B) Only statement II is correct. C) Both statements are correct. D) Neither statement is correct.

Answers: A Explanation: Only statement I is correct. I. That the economic purpose of the transaction must exceed the tax avoidance motive.

Darcy borrowed $4,000 in 2016 from her employer to purchase a new computer. She repays $1,000 of the loan plus 6% interest on the unpaid balance in 2016, 2017, and 2018. After closing a big deal in 2019, she receives the original loan agreement stamped "paid in full" across the face. Under what concept/doctrine will Darcy recognize any income from the cancellation of the loan in 2019?

Claim of right doctrine: A realization occurs whenever an amount is received without restriction as to its disposition. An item is received without restriction when the receiver has no definitive obligation to repay the amount received.

Darcy borrowed $4,000 in 2018 from her employer to purchase a new computer. She repays $1,000 of the loan plus 6% interest on the unpaid balance in 2018, 2019, and 2020. After closing a big deal in 2020, she receives the original loan agreement stamped ``paid in full'' across the face. Does Darcy have to recognize any income from the cancellation of the loan in 2020?

Darcy has obtained a claim of right to the $1,000 ($4,000 - $3,000) loan balance. Because she is no longer under a strict obligation to repay the $1,000, it is included in her 2020 gross income. The cancellation of the loan balance by her employer is a form of compensation and must be included in income when she obtains a claim of right to the income.

Bear Company provides all its employees with a $10,000 group term life insurance policy. Elk Company does not provide any life insurance but pays $10,000 to survivors of employees who die. Jackie, an employee of Bear Company, and her sister-in-law, Rosetta, an employee of Elk Company, both die during the current year. Their husbands, Bo and Carl, do not understand the tax effects of the $10,000 payments they receive. Complete the letter to Bo and Carl, which outlines the tax treatment for the $10,000 payments each receives.

Dear Bo and Carl, With regard to the distribution of benefits for your spouses, Jackie and Rosetta, the following information is provided. For Jackie's Bear Company group term life payment, Bo can exclude from gross income as this amount is not taxable to the recipient . For Rosetta's Elk Company death benefit payment, Carl must include in gross income.

Earl is a student at Aggie Tech. He receives a $5,000 general scholarship for his outstanding grades in previous years. Earl is also a residence hall assistant, for which he receives a $1,000 tuition reduction and free room and board worth $6,000 per year. Earl's annual costs for tuition, books, and supplies are $8,000. Does Earl have any taxable income from the scholarship or the free room and board?

Earl has $7,000 ($6,000 + $1,000) of income from the receipt of the free room and board. Even if the room and board were considered to be a scholarship, it could not be excluded because it is designated for payment of costs that are not direct education costs. The $5,000 general scholarship is excluded because it is less than the actual direct costs.

A fire extensively damaged a small Alaska town where Intech Company had its primary plant. Intech decided to give $200 to each household that lost its residence. About 12% of the payments were made to Intech employees. Is the receipt of $200 by some Intech employees taxable as compensation or excludable as a gift?

Excludable as a gift. In 1960, the U.S. Supreme Court agreed that the critical consideration is the transferor's intention.

In 2020, Herbert and Geraldine have a taxable income of $28,000 before considering the gain they realize on the sale of 500 shares of Olebolla Corporation common stock for $26 per share. Herbert had acquired the shares for $3 per share while he worked for Olebolla through the company's employee incentive program. He retired from the company five years ago. What is the effect of the sale on Herbert and Geraldine's taxable income and their income tax liability?

Herbert and Geraldine have an $11,500 [500 x ($26 - $3)] long-term capital gain on the sale of the shares. The gain is added to their gross income and increases their taxable income to $39,500. Net long-term capital gains are generally taxed at 15%. Taxpayers in the 10% or 15% marginal tax rate bracket pay a 0% capital gains rate. Because Herbert and Geraldine are in the 15% rate bracket, their gain is not taxed. Their income tax liability is $3,267: Tax on ordinary income $1,855 + [15% x ($28,000 - $18,650)] $3,267 Tax on long-term capital gain - $11,500 x 0% 0

What is meant by a hybrid method of accounting?

In the hybrid method of accounting, sales of merchandise and the cost of merchandise sold (i.e., cost of goods sold) are accounted for on the accrual basis. All other income and expense items that are not related to the sale of merchandise are accounted for using the cash basis. The hybrid method is a cash basis of accounting for all items except sales of merchandise and the related cost of goods sold.

Allison dies during the current year. She is covered by a $1,000,000 life insurance policy payable to her husband, Bob. Bob elects to receive the policy proceeds in 10 annual installments of $120,000. Complete the letter to Bob explaining the tax consequences of his installment election.

Life insurance proceeds are excluded from tax. Therefore, the $1,000,000 face value of the policy is excluded as it is received. However, the earnings on the policy during the time it is held by the insurance company are not excludable. The total interest earned is $200,000 [($120,000 x 10) - $1,000,000]. As each payment on the policy is received, Bob will exclude $100,000 ($1,000,000 ÷ 10) and include $20,000 ($200,000 ÷ 10) in gross income.

Ramona is a production supervisor for White Company. During the current year, her division had no accidents, and White rewarded the achievement with a $200 cash award to each employee in the division. Does Ramona have to include the award in her income?

Prizes and awards are generally taxable. Up to $400 of an award of tangible, personal property for length of service or safety is excluded. Because Ramona's safety award is paid in cash (not tangible, personal property), it is a taxable award.

Anna enters a sweepstakes contest that was advertised on the back of a cereal box and wins $30,000. The prize will be paid out in 30 annual installments of $1,000. She receives her first check in 2020. How much income must Anna report in 2020?

Prizes and awards are taxable. Anna is only taxed on the $1,000 she received in 2020. She is not in constructive receipt of the remaining $29,000 because it is not available for her use.

Pablo wins a new automobile on a television game show. The car has a listed sticker price of $31,500. A dealer advertises the same car for $30,000. How much income does Pablo have from the receipt of the car?

Prizes and awards are taxable. Because the prize was won, it does not meet the exception for exclusion of certain types of awards. Pablo is taxed on the fair market value of the car. The sticker price of $31,500 provides only a guide to the fair market value of the car. However, if the car can be bought in an arm's-length transaction at a lower amount than the sticker price, then that is the value to be included in gross income.

How is the degree of completion of a long-term construction contract determined?

The degree of completion of a long-term construction contract is determined by the ratio of costs incurred during the year to the total estimated cost of the contract.

How does the wherewithal-to-pay concept affect the tax treatment of prepaid income?

The wherewithal-to-pay concept affects the tax treatment of prepaid income received by accrual basis taxpayers. •Under strict accrual accounting, prepaid income is deferred for recognition to the period in which the income is earned. •However, the wherewithal-to-pay concept requires the tax to be paid in the period in which the taxpayer has the cash available to pay the tax. Under this concept, most receipts of prepaid income by an accrual basis taxpayer are included in gross income in the period of receipt, rather than the period in which the income is earned.

Chuck is the sole owner of Ransom, Inc., a corporation. Chuck purchased a machine from Ransom for $10,000. Ransom had paid $50,000 for the machine, which was worth $30,000 at the time of the sale to Chuck. Does Chuck recognize any income?

This is a bargain purchase. Chuck has dividend income of $20,000 ($30,000 - $10,000) from the purchase. Chuck and Ransom are related parties and do not deal at arms-length. The sale below market value is considered a dividend to Chuck.

For vs. From AGI

Trade or business expenses are deducted for adjusted gross income, whereas production-of-income expenses are subtracted fromadjusted gross income.

What effect does an asset's adjusted basis have in determining the gain or loss realized upon its sale?

Under the capital recovery concept, income is not realized until all capital invested in an asset has been recovered. •An asset's adjusted basis represents capital investment that has not been recovered. •Therefore, a gain on the sale of an asset results when the asset is sold for more than its adjusted basis. •A loss occurs when all capital investment has not been recovered through sale -- the asset is sold for less than its adjusted basis.

Determine the amount of income that must be recognized: Lenny retires from the Brice Company this year. At his retirement reception, the company gives him a set of golf clubs valued at $600 in appreciation of his years of loyal service. Assume that Brice Company does not have a qualified plan.

Up to $400 of an award of tangible, person property for length of service or safety is excluded. The exclusion is increased to $1,600 if the award is made from a qualified plan. Answer: $200

Lenny retires from the Brice Company this year. At his retirement reception, the company gives him a set of golf clubs valued at $600 in appreciation of his years of loyal service. How much can Lenny exclude if Brice Company does not have a qualified plan? How much can Lenny exclude if Brice Company has a qualified plan?

Up to $400 of an award of tangible, personal property for length of service or safety is excluded. The exclusion is increased to $1,600 if the award is made from a qualified plan. If Brice Co. does not have a qualified plan, then Lenny has $200 ($600 - $400) of income from the receipt of the golf clubs. If Brice has a qualified plan, then Lenny has no income from the receipt of the golf clubs.

Adam works during the summer as a fire watcher for the Oregon forest service. As such he spends three weeks in the woods in a forest service watchtower and then gets a week off. Because of the remoteness of the location, groceries are flown in by helicopter to Adam each week. Does Adam have any taxable income from this arrangement?

Yes , Adam must include the cost of groceries as the "provided by the employer" provision was not met

Max owns an office building that he rents for $750 a month. Under the terms of the lease, the tenant is responsible for paying all property taxes and costs related to the building's operation and maintenance. The only cost to Max in relation to the lease is an annual legal fee for renewing the lease. Is Max engaged in the trade or business of renting real estate? ____ The attorney fees are a ______.

Yes; deductible business expense

Chet is an officer of the Branson Corporation, a publicly traded corporation. His salary for the year is $1,320,000, which is the sixth-highest salary at Branson. a. What amount can the corporation deduct as salary expense? b. If Chet has the third-highest salary at Branson, then Branson Corporation is subject to the _____ limitation on Chet's salary.

a. $1,320,000 b. $1,000,000

Jan owns the Mews Bar and Grill. Every year at Christmas, he has a party for his 20 employees and their families. This year's party cost $1,600. At the party, Jan presented each employee with a $50 gift certificate redeemable for merchandise at a local department store. a. If the gift certificates are deemed de minimis fringe, how much can Jan deduct for business and gift expenses? b. Assume that the party is attended by 10 employees and 10 of the Mews's major suppliers. At the party each receives a holiday cheese basket that cost $30.

a. $2,060 Employee recreational expenses are not subject to the 50% limitation on meals & entertainment. De minimum fringe = not considered compensation, but either way employer can deduct. b. $2,150

Throughout the textbook, it has been stated that tax relief can come in several forms. Assuming that the taxpayer in question is in a 24% marginal tax rate bracket and the time value of money is 6% (present value factor = .747), what is the tax value of the following forms of relief? Round the tax value to the nearest dollar. a. A $2,000 item of income that is excluded from income. b. A $2,000 expenditure that is deductible in computing taxable income. c. A $2,000 expenditure that is eligible for a 10% tax credit. d. A $2,000 item of income that is deferred for five years (Assume no change in the marginal tax rate.)

a. $480. Because there is no tax paid on the $2,000 of excluded income, there is an implicit savings of the tax that would have been paid if the income been taxable, in this case $2,000 x 24%) b. $480. A tax deduction results in a reduction of tax - $480 tax saving at a 24% marginal tax rate. c. $200. The value of a tax credit is equal to the amount of the tax credit because it is a direct reduction in the tax liability. d. $121. The value of a deferral is equal to the time value of money tax savings on the item. In this case, the payment of the $4800 tax is deferred for 5 years. The tax savings then is equal to the difference between the $480 of tax that would have been paid currently without the deferral minus the present value of the $480 tax payment 5 years from now. The present value factor for 6% for 5 years is .747, giving a present value of $359. The all-inclusive income concept considers taxable any income received unless a specific provision can be found that exempts the item from taxation.

For each of the following situations, indicate whether a business expense are deductible or not: a. Neil owns a real estate agency and has an annual Christmas party at his house. The party is only for employees of his firm, and costs $2,600. b. Carol is a personal financial planner. Over the years, she has made it a practice to invite her best clients to lunch on the client's birthday. At the lunch, she always makes it a point to ask about any major changes in the client's financial status that she should be aware of. However, most of the conversation relates to personal matters. During the year, Carol spends $850 on these lunches. c. Vijay is a doctor at a local hospital. Every month, he buys lunch at the hospital for the six residents and interns who assist him in surgery and caring for his patients. The lunches cost $240 for the year. d. Tom, Hillary, and George are friends from college who live and work in the Dallas metropolitan area. They are all stockbrokers for different firms and get together twice a month for lunch to exchange rumors concerning the stock market. In addition, they catch up on personal news and make plans to get together with their spouses and other friends. Last year, George made $50,000 for a client based on a tip he received from Hillary at one of their meetings. Each stockbroker pays for his or her own lunch, and during the year, George paid $320.

a. Deductible b. Not deductible c. Not deductible d. Not deductible

Indicate the deductibility for each of the following expenses. a. Chander paid $500 in interest on a loan he used to purchase equipment for his retail business. b. Peter paid $500 in interest on a loan he used to purchase 1,000 shares of Pickled Pepper stock. c. Portia paid $500 in interest on a loan she used to purchase her personal automobile. d. Jordan's primary source of income is his wholesale warehousing business. During the current year, he paid $8,000 in state income taxes. e. Alphonse is a professional golfer who likes to race cars in his spare time. He spent $60,000 on expenses related to racing cars during the current year. f. Barry is an insurance agent. He bought a golf cart and had his insurance company logo put on the golf cart to attract customers while he played golf.

a. Deductible for adjusted gross income b. Deductible as an itemized deduction c. Not deductible d. Deductible as an itemized deduction e. Not deductible f. Split: cart not deductible, logo is a business expense

Ying pays $300 of investment interest related to her investments. The interest is not directly related to any particular investment owned by Ying. She owns $40,000 worth of municipal bonds that pay her $2,400 in interest and $20,000 worth of bonds that pay her taxable interest of $2,000. a. Ying allocates the investment fees based on the fair market value of the securities. The allocation between the nondeductible portion of the fee and the deductible portion is: b. Investment expenses can be allocated based on investment income. If Ying uses this method, the allocation between the nondeductible portion of the fee and the deductible portion is:

a. Deductible: $100 Nondeductible: $200 b. Deductible: $136 Nondeductible: $164

Courtney is an employee of Fremont Company. An average of three times a week, she works out during her lunch hour at a health club provided by Fremont. What is the taxability of Fremont's provision of the health club in the following situations? a. The health club is owned by Fremont and is located on its business premises. All employees and their dependents are allowed to use the facility. The cost of joining a comparable facility is $60 per month. b. The health club is located in Fremont's office building but is owned by Manzer Fitness World. Fremont pays the $60 per month health club dues. c. Fremont is in the health club business. The health club is used primarily by customers, although several employees, including Courtney, use it, too. Assume that all employees are not allowed to use the health club.

a. Excluded from gross income b. Included in gross income c. Included in gross income

Determine whether Frank or Dorothy (Frank's friend) or both are taxed on the income in each of the following situations. a. Frank owns 8% bonds with a $10,000 face value. The bonds pay interest annually on June 30. On September 30, Frank makes a bona fide gift of the bonds to Dorothy. b. A few years ago, Frank wrote a best-selling book about computers. On August 1, he instructs the publisher to pay all future royalties to Dorothy. c. Frank owns 1,000 shares of Pujan stock. On May 1, Pujan declares a $12-per-share dividend to shareholders of record as of June 1. On May 15, Frank gives the Pujan stock to Dorothy. She receives the $12,000 dividend on June 30.

a. Frank and Dorothy b. Frank c. Frank Assignment-of-income doctrine - The tax entity that owns the income produced is responsible for the tax on the income, regardless of which entity actually receives the income. Merely directing payment of income (assigning income) that has been earned by one entity to another, although legal, does not relieve the owner of the income from paying tax.

For 2019, Pablo is a computer sales representative and spends only 4 days a month in the office. His office is 18 miles from home. Pablo spends 3 nights a month traveling to his out-of-town clients. a. What portion of Pablo's travel is considered business? b. During the year, Pablo keeps the following record of his travel: Home to office - 864 miles Office to home - 864 miles Home to local clients to home - 10,630 miles Home to out-of-town clients to home - 2,650 miles The company reimburses Pablo for all of his lodging, meals, and entertainment while he is on the road. If he uses the standard mileage rate, what amount can he deduct as a business expense? Note: The standard mileage rate for 2019 is 58 cents per mile.

a. The portion of Pablo's travel from home to his business clients and back is considered business and fully deductible . All out-of-town miles are deductible. The home to office miles are nondeductible. b. $7,702

Fawn receives a $2,500 scholarship to State University. The scholarship is paid by the finance department. Recipients are required to work 10 hours per week for a professor designated by the department. Indicate whether the following statements are true or false: a. This is not a scholarship that is eligible for exclusion. b. To be excluded from income, a scholarship must be gratuitous in nature and not be a form of compensation.

a. True b. True

Fawn receives a $2,500 scholarship to State University. The scholarship is paid from a general scholarship fund and is awarded to students with high academic potential. Recipients are not required to perform any services to receive the scholarship. Indicate whether the following statements are true or false: a. The scholarship is excluded from income to the extent of Fawn's direct education costs. b. The scholarship is excluded because it was awarded based on academic potential. c. The scholarship is included as Fawn lives in the dorm.

a. True b. True c. False

a. Dorothy owns a real estate business. She is enrolled in a one-year weekend MBA program that meets in a city three hours away. She takes a train to and from the city. A one-year weekend pass for the train is $800. The fee for the MBA program, including lodging, meals, books, and tuition, is $25,000. b. Forest is employed as a production manager for a printing company. He is enrolled in a night course costing $350 at the local college. The course is not required by his employer but does improve his job skills. c. Elise is a recent graduate of law school and has been hired by a local firm. The firm expects her to pass the bar exam on her first try. To prepare for the bar exam, she is taking a law review course that costs $1,500. d. Simon is the managing partner of an accounting firm and is required to attend 30 hours of continuing education every year. State law requires that 5 hours be in ethics training. The 5-hour ethics course costs $400; the remaining 25 hours of continuing education cost $1,800.

a.Deductible b. Deductible c. Not deductible d. Deductible

Zoie has worked for Humple Manufacturing for 16 years. Humple has a pension plan that matches employee contributions by up to 4% of an employee's salary. Zoie, age 60, is ready to retire. She has contributed $20,000 to the plan. Under Humple's pension plan, Zoie will receive $1,000 per month until she dies. Assume that Zoie is expected to live 25 more years. She wants to know the tax consequences of each pension payment that she will receive. Assume Humple's plan is not a qualified plan. Zoie has paid tax on all contributions into and earned by the plan. Because this is not a qualified plan and Zoie made her contributions with _______ dollars, the _____ she receives monthly will _____ taxed.

after tax; $1,000; not be

Alexandra is a veterinarian employed by Fast Vet Services. Susan is a self-employed veterinarian. During the current year, Alexandra and Susan have the same amounts of income and deductions. How does a deductible expense paid by Susan affect her taxable income differently than the payment of the same expense by Alexandra? Susan, because she is self-employed, ______ deduct expenditures related to her vet practices. Therefore, all of her veterinary expenses are deductible _______. Alexandra is an employee, and as such, her expenditures are considered unreimbursed expenses. She _________ these expenditures.

can; for adjusted gross income; can deduct as itemized deductions

Zoie has worked for Humple Manufacturing for 16 years. Humple has a pension plan that matches employee contributions by up to 4% of an employee's salary. Zoie, age 60, is ready to retire. She has contributed $20,000 to the plan. Under Humple's pension plan, Zoie will receive $1,000 per month until she dies. Assume that Zoie is expected to live 25 more years. She wants to know the tax consequences of each pension payment that she will receive. Assume Humple's plan is a qualified pension plan. Under qualified plans, payments made into the plan and all income earned on those payments were _______. When Zoie begins receiving payments from the plan, she must _______ all of the income. Thus, Zoie will have _______ per month of gross income from each payment.

deferred; recognize; $1,000

Albert and Patricia are divorced and their agreement is finalized in 2018. As part of their divorce agreement, Patricia agrees to pay Albert alimony of $85,000 in the current year and $5,000 per year in subsequent years. Based on the agreement, complete the statement: The _______ between the payments would lead one to believe that the first year payment is, in fact, _________.

disparity; part alimony, part property settlement

Pablo wins a new automobile on a television game show. The car has a listed sticker price of $31,500. A dealer advertises the same car for $30,000. How much income does Pablo have from the receipt of the car? If the car can be bought in an arm's-length transaction at a _______ amount than the sticker price, then that is the value to be _______ in gross income.

lower; included

Patz Corporation owns a gourmet restaurant. The restaurant needs to remodel its kitchen but is short of cash. Dennis owns Tucky's Accessories, a restaurant supply store. The manager of Patz makes a deal with Dennis to have Tucky's do the kitchen remodeling, in exchange for which Patz will cater Tucky's company picnic. Tucky's does the remodeling and Patz caters the picnic. It costs Patz $800 to cater the picnic, a job for which it would have charged $1,500. All income received is ________. ______ Patz _____ Tucky must report the income. Patz reports an income of ______ from _______ and Tucky reports an income of ________ from ___________

taxable; both; and; $1,500; catering; $1,500; remodeling

What is a bargain purchase?

•A bargain purchase occurs when a product or service is sold at a price below the normal selling price in an attempt to compensate the purchaser. •That is, the transaction is not made at arms-length between the seller and the buyer but is intended to be for the mutual benefit of both the seller and the buyer. •This is distinguished from those situations in which the buyer of the product or services bargains at arms-length with the seller and obtains a price below the normal selling price. In such cases, the seller and the buyer both benefit from the immediate sale, but there is no long-term benefit to either the buyer or the seller from the reduced sales price.

•What is a cash equivalent? •How does a cash equivalent affect the reporting of income?

•A cash-equivalent is anything with a determinable fair market value. •A cash basis taxpayer must recognize income when she or he is in constructive receipt of the income. •Under the all-inclusive income concept, income may be received in any form. •Therefore, the receipt of a cash equivalent is reported as income in the period of its actual or constructive receipt. The purpose of this approach is to stop cash basis taxpayers from realizing some of their income in the form of property or services to avoid reporting the income earned.

How is capital gain income treated differently from other forms of income?

•Capital gains and losses are netted separately from all other forms of income. If the result of the netting is a long-term capital gain, the gain is taxed at a rate of 15% for individuals. The rate is reduced to 0% for taxpayers in the 10% or 15% marginal tax rate bracket and increased to 20% for taxpayers in the 37% marginal tax rate bracket. •Net collectibles gains are taxed at a maximum rate of 28%. •If the result of the capital gain and loss netting is a loss, individuals may only deduct $3,000 of net capital loss against other forms of income with any remaining loss carried forward to subsequent years' netting. • Corporations receive no special treatment for net capital gains. •Corporations are only allowed to deduct losses against capital gains and cannot deduct any of the capital loss against other forms of income. Any remaining capital loss can be carried back three years or forward for five years.

What is the difference between earned income and unearned income?

•Earned income is a payment for human capital. That is, it results from the provision of labor and services for which payment or a profit (in the case of a sole proprietor) is received. •Unearned income is a payment for a return on an investment. The taxpayer invests money or other assets. An amount is received for the use of the assets. There is no direct investment of human capital.

How is the definition of income for income tax purposes different from the definition used by economists to measure income?

•Economists measure income as the change in wealth that occurs during a year. As such, all increases and decreases in the value of assets, whether they are actually realized, are part of the change in wealth. •The income tax definition includes only those changes in wealth that are realized by the taxpayer during the year. Thus, the income tax law does not tax as income increases (decreases) in the value of assets that have not been realized in an arm's-length transaction.

Are all losses realized on the sale of capital assets deductible?

•No, losses realized may not be currently deductible. •Net capital loss deductions of individuals are limited to $3,000 per year with any excess loss carried forward to future years for deduction (subject to that year's netting and $3,000 limit). •Personal use assets are capital assets. Losses on personal use assets are never deductible. Thus, the sale of a personal use asset at a loss is not deductible.

What is the difference between realized income and recognized income?

•Realized income occurs when a taxpayer receives an increase in wealth in an arm's length transaction. •Recognized income is income that is taxed in the current tax year. Therefore, all recognized income must first be realized. •However, all realized income may not be recognized currently. Some forms of income are excluded permanently from tax (e.g., municipal bond interest), while other forms of income are deferred for recognition in a future period (e.g., gains from like-kind exchanges, involuntary conversions, etc.).

Are Social Security benefits taxable?

•Social Security payments are subject to tax based on the taxpayer's economic income. •The maximum amount subject to tax is 85% of the Social Security benefits received. •However, if the taxpayer's economic income (as defined by the Social Security formula) is below the base amount ($25,000 single, $32,000 married, filing joint), then the taxpayer pays no tax on the Social Security benefits received.

What is the purpose of the capital gain and loss netting procedure?

•The primary purpose of the capital gain-and-loss netting procedure is to reduce all capital gains and losses for the year into a single position that is either a gain or loss for the year. •The netting procedure also identifies gains and losses as being either net short-term or net long-term gains or losses. •The purpose of this part of the netting is to allow favorable tax treatment for net long-term capital gains, and net collectibles gains.

•Prizes and awards are generally taxable. •Under what conditions is the receipt of a prize or award not taxable?

•There are 2 circumstances in which a prize or award is not taxable. •If the award is for a scientific, literary, educational, musical, or other such achievement and there is no future obligation to perform services as a result of the award, the recipient of the award may exclude the value of the award if the award is given to a charitable, educational, or governmental organization. •Awards to employees of tangible property that are based on length of service or safety achievements are also excluded. The maximum exclusion is $400, unless the award comes from a qualified plan, in which case the maximum exclusion is $1,600.