Tax Accounting - Chapter 12 Learn Smart

Tyler has a 24 percent marginal tax rate. His employer is willing to provide health insurance coverage for Tyler if he will agree to a salary reduction. The insurance will cost the employer $5,040. If Tyler pays that same amount for health insurance premiums, he will need $7,000 in order to pay the premiums and the taxes on the compensation. How much of a cash flow savings is available to the company if it pays $5,040 for Tyler's health insurance, rather than $7,000 in compensation assuming the company has a 21 percent tax rate? a. $1,548 b. $2,481 c. $1,960

$1,548 = (7,000-5040) x (1-.21)

Employers are generally allowed to deduct reasonable compensation paid to employees, but the level of deductible compensation is limited to a maximum of________ for the CEO, CFO, and the next three highest paid officers of publicly traded corporations unless certain exceptions are met.

1,000,000

Employees who receive compensation in the form of [Blank 1] stock do not have to pay for it, but forfeit ownership if they quit before the [Blank 2] date.

Blank 1: Restricted Blank 2: Vesting

The bargain element is equal to the difference between the [Blank 1] price and the fair [Blank 2] value of the acquired shares on the date of exercise.

Blank 1: exercise price Blank 2: fair market value

By making a Section 83(b) election, the employee is taxed on the value of the restricted stock on the [Blank 1] date, rather than the [Blank 2] date.

Blank 1: grant Blank 2: vesting or vest

Taxable fringe benefits are subject to both federal [Blank 1] tax and [Blank 2] tax.

Blank 1: income Blank 2: FICA or payroll

1. The type of compensation where employees receive a fixed amount regardless of the amount of hours worked is called a(n) [Blank 1] 2. The type of compensation that is based on the number of hours worked is called [Blank 2] 3. Both types of compensation are taxed at to employees as [Blank 3] income and subject to [Blank 4] tax which includes Social Security and Medicare.

Blank 1: salary or salaries Blank 2: wages, hourly, or wage Blank 3: ordinary or marginal Blank 4: FICA

Employees receiving restricted stock are taxed on the fair market value of the shares on the [Blank 1] date (absent an election).

Blank 1: vesting or vest

Nontaxable fringe benefits are very attractive to employees because their after-tax cost for these benefits is [Blank 1] The cost of the benefits is [Blank 2] (nondeductible/deductible) for the employer.

Blank 1: zero, 0, or nothing Blank 2: deductible

Equity-Based Compensation

Compensation can provide motivational effects to employees and cash flow benefits to the company.

Which of the following choices are characteristics of stock options? (Check all that apply.) a. Employees may purchase the stock on the grant date, but can NOT sell their shares until the vesting date. b. Employees may choose NOT to exercise their options if the market value of the shares is below the strike price. c. Employees may exercise their options by paying the strike price to the employer anytime between the vesting and expiration dates. d. The employee will receive the stock on the vesting date without having to pay for it. e. If the market price is below the strike price, the employee may purchase the stock at FMV and sell it to the company for the option price.

Employees may choose NOT to exercise their options if the market value of the shares is below the strike price. Employees may exercise their options by paying the strike price to the employer anytime between the vesting and expiration dates.

Match the description with the type of equity-based compensation listed. • Employees receive the stock on the vesting date without having to pay for it. • Employees must use cash to purchase the employer's stock once the vesting date is reached. with the type of equity-based compensation listed. • Stock options • Restricted stock

Stock option: Employees must use cash to purchase the employer's stock once the vesting date is reached. Restricted stock: Employees receive the stock on the vesting date without having to pay for it.

Which of the following choices is a characteristic of restricted stock? a.Employees must use cash to purchase the employer's stock once the vesting date is reached. b. Employees may purchase the stock on the grant date, but can NOT sell their shares until the vesting date. c. The employee is not required to pay for the stock but rather is given the shares on the grant date. d. Employees must purchase the stock on the vesting date regardless of the market price.

The employee is not required to pay for the stock but rather is given the shares on the grant date.

True or False: Current compensation is usually comprised of salary, wages, and bonuses.

True

True or False: Employees prefer to receive ISOs rather than NQOs because any gain on the subsequent sale of the stock may be taxed as a long-term capital gain if the required holding periods are met. True false question.

True Reason: NQOs are taxed differently. The bargain element is actually taxed as ordinary income on the exercise date which can present a cash flow shortage for those purchasing the stock.

Which of the following statements is CORRECT regarding compensation expense for employers in publicly traded corporations? a. Deductible compensation expense must be considered reasonable under the facts and circumstances of the employment. b. Most performance-based compensation contracts in effect on November 2, 2017 are excluded from the limit. c. Companies are only allowed to pay compensation of $1 million each to the top four executives. d. The tax-deductible compensation is limited to $2 million for the CEO and $1 million for the next four most highly paid employees.

a. Deductible compensation expense must be considered reasonable under the facts and circumstances of the employment. Reason: • Performance-based compensation is excluded from the limit. • The limit applies to the CEO, CFO, and next three highest-paid officers. (5)

Which of the following choices are characteristics of stock options? (Check all that apply.) a. Employees may choose NOT to exercise their options if the market value of the shares is below the strike price. b. The employee will receive the stock on the vesting date without having to pay for it. c. Employees may purchase the stock on the grant date, but can NOT sell their shares until the vesting date. d. Employees may exercise their options by paying the strike price to the employer anytime between the vesting and expiration dates. e. If the market price is below the strike price, the employee may purchase the stock at FMV and sell it to the company for the option price.

a. Employees may choose NOT to exercise their options if the market value of the shares is below the strike price. d. Employees may exercise their options by paying the strike price to the employer anytime between the vesting and expiration dates.

Which of the following statements is INCORRECT regarding the timing of employer deductions for compensation and the employees' inclusion of compensation in gross income? a. Employers must deduct the compensation the same year that the employees include the amounts in gross income regardless of the accounting method. b. Employers using the cash method of accounting must deduct salaries and wages in the year they pay the employees. c. Employers using the accrual method of accounting must deduct salaries and wages in the year the employees earn the compensation. d. When the employer and the employee are related, the employer must deduct wages expense in the same year the employee reports it as gross income.

a. Employers must deduct the compensation the same year that the employees include the amounts in gross income regardless of the accounting method.

Which of the following statements is correct regarding employers' treatment of salaries and wages? a. Employers using the accrual method of accounting must deduct salaries and wages in the year the employees earn the compensation. b. Employers must deduct the compensation the same year that the employees include the amounts in gross income regardless of the accounting method. c. When the employer and the employee are related parties, both parties must use the accrual method to recognize the deduction and the income. d. Employers using the cash method of accounting must deduct salaries and wages in the year the employees earn the compensation.

a. Employers using the accrual method of accounting must deduct salaries and wages in the year the employees earn the compensation.

How is the amount of the employer's tax deduction for restricted stock determined? a. The amount of the deduction equals the ordinary income that is recognized by the employees. b. The amount of the deduction equals the fair market value of the stock on the vesting date. c. The employer does not receive a tax deduction for issuing restricted stock to its employees. d. The amount of the deduction equals the fair market value of the stock on the grant date.

a. The amount of the deduction equals the ordinary income that is recognized by the employees.

Which one of the following characteristics applies to taxable fringe benefits? a. The cost of the taxable fringe benefit is deductible to the employer, not the value of the benefit to the employee. b. Employers are not allowed a deduction for taxable fringe benefits as they are not treated the same as cash compensation. c. Employees are not subject to FICA tax on taxable fringe benefits. d. Employers may NOT discriminate between employees, but must offer the same taxable fringe benefits to all employees regardless of compensation level.

a. The cost of the taxable fringe benefit is deductible to the employer, not the value of the benefit to the employee.

Why are nontaxable fringe benefits attractive to both the employer and the employees? a. The net after-tax cost to employees is zero and the employer receives a tax deduction for the cost of the benefit. b. The net after-tax cost to employees is zero and the employer may provide the benefits on a discriminatory basis. c. The net after-tax cost to employees is zero, but the employer receives NO tax deduction for the cost of the benefit. d. The employees are NOT taxed on the benefit until it is used/received and the employer receives a tax deduction for the cost of providing the benefit.

a. The net after-tax cost to employees is zero and the employer receives a tax deduction for the cost of the benefit.

Which of the following statements is correct when describing the tax treatment to the employees of stock options? a. There are no tax consequences on the grant date or the vesting date for both ISOs and NQOs. b. The bargain element is taxed as ordinary income on the grant date for NQOs. c. The bargain element is taxed as ordinary income on the grant date for ISOs. d. The bargain element is taxed as ordinary income on the vesting date for both ISOs and NQOs.

a. There are no tax consequences on the grant date or the vesting date for both ISOs and NQOs.

How are salaries and wages taxed? (Check all that apply.) a. They are taxed when received, rather than when earned. b. They are taxed as capital gains. c. They are taxed when earned, rather than when the money is received. d. They are taxed as ordinary income. e. They are subject to FICA tax.

a. They are taxed when received, rather than when earned. d. They are taxed as ordinary income. e. They are subject to FICA tax.

Accounts in which employees are allowed to set aside a portion of their before-tax salary to pay either health and/or dependent-care benefits are called: a. flexible spending accounts b. cafeteria plan accounts c. Patient Protection and Affordable Care accounts d medical expense accounts

a. flexible spending accounts

Van Winkle received stock options from his employer, RiP, Inc. The options entitled Van to purchase 100 shares of RiP common stock at an exercise price of $20 per share. The options vested when the market price of the stock was $32 per share. Van exercised his options on the vesting date. He sold the stock several months later for $38 per share. What is the total bargain element on Van's stock? a. $2,000 b. $1,200 c. $1,800 d. $600

b. $1,200 Reason: ($32-$20) x 100; $12 x 100 = $1,200 Employees who exercise options to purchase employers stock experience an increase in before-tax net worth equal to the difference between the market value of the acquired shares and the exercise price on the date of exercise. This difference is called the bargain element.

Which of the following statements is CORRECT regarding compensation expense for employers in publicly traded corporations? a. Companies are only allowed to pay compensation of $1 million each to the top four executives. b. Deductible compensation expense must be considered reasonable under the facts and circumstances of the employment. c. The tax deductible compensation is limited to $2 million for the CEO and $1 million for the next four most highly paid employees. d. Most performance-based compensation contracts in effect on November 2, 2017 are excluded from the limit.

b. Deductible compensation expense must be considered reasonable under the facts and circumstances of the employment.

Why do employees prefer ISOs to NQOs? a. ISOs result in gains that are exempt from taxation in the year the employee disposes of the stock. b. Employees who meet the required holding period for ISOs will treat the difference between the sales proceeds and exercise price as a long-term capital gain. c. The bargain element is NOT taxed for ISOs which results in a lower gain to the employee when the stock is sold. d. Employees who sell stock that was purchased with NQOs will recognize ordinary income on the entire realized gain regardless of holding period.

b. Employees who meet the required holding period for ISOs will treat the difference between the sales proceeds and exercise price as a long-term capital gain. Book reference pg 12-12 When they sell, employees will treat the difference between the sale proceeds and the tax basis (the exercise price) as a long-term capital gain in the year of disposition.

Which of the following fringe benefits are nontaxable fringe benefits for the recipient? (Check all that apply.) a. Season tickets for the local NFL team b. Employer-paid health insurance c. Employer-paid premiums on a $50,000 group-term life insurance policy d. A below-market loan provided to an employee who needed an advance on his pay e. The cost of meals and lodging that is for the convenience of the employer

b. Employer-paid health insurance c. Employer-paid premiums on a $50,000 group-term life insurance policy e. The cost of meals and lodging that is for the convenience of the employer

Which of the following characteristics apply to taxable fringe benefits? (Check all that apply.) a. Employers may NOT discriminate between employees, but must offer the same taxable fringe benefits to all employees regardless of compensation level. b. Employers treat the taxable fringe benefits the same as cash compensation. c. Employees are taxed on the value of the benefit, rather than the cost paid for the benefit. d. The cost of the taxable fringe benefit is deductible to the employer, not the value of the benefit to the employee.

b. Employers treat the taxable fringe benefits the same as cash compensation. c. Employees are taxed on the value of the benefit, rather than the cost paid for the benefit. d. The cost of the taxable fringe benefit is deductible to the employer, not the value of the benefit to the employee.

Concerning employees, which of the following statements is INCORRECT when considering fringe benefits? a. Taxable fringe benefits are treated like cash compensation. b. Taxable fringe benefits are generally available to all employees on a nondiscriminatory basis. c. Taxable fringe benefits are taxed at ordinary rates. d. Employees must pay FICA tax in addition to income tax on taxable fringe benefits.

b. Taxable fringe benefits are generally available to all employees on a nondiscriminatory basis.

Which of the following characteristics apply to taxable fringe benefits? (Check all that apply.) a. Employers may NOT discriminate between employees, but must offer the same taxable fringe benefits to all employees regardless of compensation level. b. The cost of the taxable fringe benefit is deductible to the employer, not the value of the benefit to the employee. c. Employees are taxed on the value of the benefit, rather than the cost paid for the benefit. d. Employers treat the taxable fringe benefits the same as cash compensation.

b. The cost of the taxable fringe benefit is deductible to the employer, not the value of the benefit to the employee. c. Employees are taxed on the value of the benefit, rather than the cost paid for the benefit. d. Employers treat the taxable fringe benefits the same as cash compensation.

Which of the following choices are characteristics of restricted stock? (Check all that apply.) a. Employees must use cash to purchase the employer's stock once the vesting date is reached. b. The employee may sell the stock immediately after the vesting date or retain it, but there is NO required holding period. c. The employee is not required to pay for the stock but rather is given the shares on the grant date. d. Employees may purchase the stock on the grant date, but can NOT sell their shares until the vesting date.

b. The employee may sell the stock immediately after the vesting date or retain it, but there is NO required holding period. c. The employee is not required to pay for the stock but rather is given the shares on the grant date.

Which of the following statements is correct when describing the tax treatment to the employees of stock options? a. The bargain element is taxed as ordinary income on the vesting date for both ISOs and NQOs. b. There are no tax consequences on the grant date or the vesting date for both ISOs and NQOs. c. The bargain element is taxed as ordinary income on the grant date for ISOs. d. The bargain element is taxed as ordinary income on the grant date for NQOs.

b. There are no tax consequences on the grant date or the vesting date for both ISOs and NQOs.

Which of the following choices describes disadvantages to the company of offering equity-based compensation in place of cash compensation? (Check all that apply.) a. In order to offer equity-based compensation, the company incurs a large cash outflow because it must first purchase the shares on the open market. b. There is an opportunity cost of selling the stock to employees at a discounted price rather than selling it for fair market value on the open market. c. The stock price on the market is likely to drop significantly if it is known that some individuals are buying at a discounted price. d. The number of shares outstanding increases which causes earnings per share to be diluted.

b. There is an opportunity cost of selling the stock to employees at a discounted price rather than selling it for fair market value on the open market. d. The number of shares outstanding increases which causes earnings per share to be diluted.

A small benefit received from working in a company, such as the freedom to make a few personal copies or use the fax machine, is referred to as a: a. qualified employee discount b. de minimis fringe benefit c. working condition fringe benefit d. cafeteria plan

b. de minimis fringe benefit

Tyler earns $80,000 per year and has a 22 percent marginal tax rate. His employer is willing to provide health insurance coverage for Tyler if he will agree to a salary reduction. The insurance will cost the employer $4,680. How much salary should Tyler be willing to forgo to receive the $4,680 in health insurance coverage? a. $4,680 b. $5,710 c. $6,000

c. $6,000 Reason: $4,680/(1-.22) = $6,000

Which one of the following statements is INCORRECT when referring to flexible spending accounts (FSAs)? a. The money in the account is set aside "before-tax" meaning that the money in the account is not subject to income tax. b. The money in the account must be used for qualified medical-related expenses or dependent care. c. Any money in the account at year end may be withdrawn and is taxable to the employee when received. d. Any money remaining in the account after the first two and a half months following the year end will be forfeited by the employee.

c. Any money in the account at year end may be withdrawn and is taxable to the employee when received.

Which of the following choices is a characteristic of stock options? a. Employees may purchase the stock on the grant date, but can NOT sell their shares until the vesting date. b. If the market price is below the strike price, the employee may purchase the stock at FMV and sell it to the company for the option price. c. Employees may exercise their options by paying the strike price to the employer anytime between the vesting and expiration dates. d. Employees must exercise their options on the vesting date regardless of the market price.

c. Employees may exercise their options by paying the strike price to the employer anytime between the vesting and expiration dates. Reason: why is not answer a Employees may not purchase the stock until the vesting date. Once the stock is purchased, they can sell at any time. Reason: why is not answer d Employees do not have to exercise their options (i.e. purchase the stock) if they do not choose to do so. If the market price is below the exercise price, they should not exercise their options.

Which one of the following choices describes a disadvantage to the company of offering equity-based compensation? a. In order to offer equity-based compensation, the company incurs a large cash outflow because it must first purchase the shares on the open market. b. The number of shares outstanding decreases which causes earnings per share to be overstated. c. There is an opportunity cost of selling the stock to employees at a discounted price, rather than selling it for fair market value on the market. d. The stock price on the market is likely to drop significantly if it is known that some individuals are buying at a discounted price.

c. There is an opportunity cost of selling the stock to employees at a discounted price, rather than selling it for fair market value on the market. Reason: The number of shares outstanding will increase which causes EPS to be diluted for the existing shareholders.

Which of the following choices is NOT an advantage of equity-based compensation? a. Equity-based compensation motivates employees to take ownership in their company. b. Equity-based compensation allows companies to reward employees without incurring cash outflows. c. If the company's stock price increases after options are granted, the employees may benefit greatly. d. Equity-based compensation is exempt from taxation for the employees.

d. Equity-based compensation is exempt from taxation for the employees.

What is the advantage of having a cafeteria plan over a standard package of benefits? a. In a cafeteria plan, an employee can receive a higher level of benefits than is offered in a standard plan. b. In a cafeteria plan, any cash received in lieu of benefits is a nontaxable fringe benefit. c. In a cafeteria plan, the employer chooses the benefits package that will be received by each employee. d. In a cafeteria plan, the employee can choose the benefits that are best suited to his or her situation.

d. In a cafeteria plan, the employee can choose the benefits that are best suited to his or her situation.

Which one of the following characteristics applies to taxable fringe benefits? a. Employers may NOT discriminate between employees, but must offer the same taxable fringe benefits to all employees regardless of compensation level. b. Employees are not subject to FICA tax on taxable fringe benefits. c. Employers are not allowed a deduction for taxable fringe benefits as they are not treated the same as cash compensation. d. The cost of the taxable fringe benefit is deductible to the employer, not the value of the benefit to the employee.

d. The cost of the taxable fringe benefit is deductible to the employer, not the value of the benefit to the employee.

What is the tax treatment for the employer when restricted stock is granted to employees? a. The employer does NOT receive a tax deduction for issuing restricted stock to employees. b. The deduction equals the ordinary income recognized by the employee and is deducted on the grant date regardless of the Sec. 83(b) election. c. The deduction equals the ordinary income recognized by the employee and is deducted on the vesting date regardless of the Sec. 83(b) election. d. The deduction equals the ordinary income recognized by the employee and the timing is based on whether or not Sec. 83(b) is elected.

d. The deduction equals the ordinary income recognized by the employee and the timing is based on whether or not Sec. 83(b) is elected.