Name: South Western Federal Taxation 2014 Comprehensive 37th Edition By William H. Hoffman - Test Bank
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Sample Questions Posted Below

COMPREHENSIVE VOLUME–CHAPTER 5–GROSS INCOME: EXCLUSIONS

Student: ___________________________________________________________________________

1. For a person who is in the 35% marginal tax bracket, $1,000 of tax-exempt income is equivalent to $1,350 of income that is subject to tax.
True False

2. John told his nephew, Steve, “if you maintain my house when I cannot, I will leave the house to you when I die. Steve maintained the house and when John died Steve inherited the house. The value of the residence can be excluded from Steve’s gross income as an inheritance.
True False

3. Brooke works part-time as a waitress in a restaurant. For groups of 7 or more customers, the customer is charged 15% of the bill for Brooke’s services. For parties of less than 7, the tips are voluntary. Brooke received $11,000 from the groups of 7 or more and $7,000 in voluntary tips from all other customers. Using the customary 15% rate, her voluntary tips would have been only $6,000. Brooke must include $18,000 ($11,000 + $7,000) in gross income.
True False

4. Mel was the beneficiary of a $45,000 group term life insurance policy on his wife. His wife’s employer paid all of the premiums on the policy. Mel used the life insurance proceeds to purchase a United States Government bond, which paid him $2,500 interest during the current year. Mel’s Federal gross income from the above is $2,500.
True False

5. Zack was the beneficiary of a life insurance policy on his wife. Zack had paid $20,000 in premiums on the policy. He collected $50,000 on the policy when his wife died from a terminal illness. Because it took several months to process the claim, the insurance company paid Zack $53,000, the face amount of the policy plus $3,000 interest. Zack must include $23,000 in his gross income.
True False

6. Ed died while employed by Violet Company. His wife collected $40,000 on a group term life insurance policy that Violet provided its employees, and $6,000 of accrued salary Ed had earned prior to his death. All of the premiums on the group term life insurance policy were excluded from the Ed’s gross income. Ed’s wife is required to recognize as gross income only the $6,000 she received for the accrued salary.
True False

7. Gary cashed in an insurance policy on his life. He needed the funds to pay for his terminally ill wife’s medical expenses. He had paid $12,000 in premiums and he collected $30,000 from the insurance company. Gary is not required to include the gain of $18,000 ($30,000 – $12,000) in gross income.
True False

8. When Betty was diagnosed as having a terminal illness, she sold her life insurance policy to Insurance Purchase, Inc., a company that is licensed to invest in these types of contracts. Betty sold the policy for $32,000 and Insurance Purchase, Inc., became the beneficiary. She had paid total premiums of $19,000. Betty died 8 months after the sale. Insurance Purchase, Inc., collected $50,000 on the policy. The company had paid additional premiums of $4,000 on the policy. Betty is not required to recognize a $13,000 gain from the sale of her life insurance policy and Insurance Purchase, Inc., is required to recognize a $14,000 gain from the insurance policy.
True False

9. Agnes receives a $5,000 scholarship which covers her tuition at Parochial High School. She may not exclude the $5,000 because the exclusion applies only to scholarships to attend college.
True False

10. If a scholarship does not satisfy the requirements for a gift, the scholarship must be included in gross income.
True False

11. Ashley received a scholarship to be used as follows: tuition $6,000; room and board $9,000; and books and laboratory supplies $2,000. Ashley is required to include only $9,000 in her gross income.
True False

12. In December 2013, Emily, a cash basis taxpayer, received a $2,500 cash scholarship for the Spring semester of 2014. However, she did not use the funds to pay the tuition until January 2014. Emily can exclude the $2,500 from her gross income in 2013.
True False

13. Betty received a graduate teaching assistantship that was awarded on the basis of academic achievement. The payments must be included in her gross income.
True False

14. In 2013, Theresa was in an automobile accident and suffered physical injuries. The accident was caused by Ramon’s negligence. In 2014, Theresa collected from his insurance company. She received $15,000 for loss of income, $10,000 for pain and suffering, $50,000 for punitive damages, and $6,000 for medical expenses which she had deducted on her 2013 tax return (the amount in excess of 10% of adjusted gross income). As a result of the above, Theresa’s 2014 gross income is increased by $56,000.
True False

15. Workers’ compensation benefits are included in gross income if the employer also pays the employee while the employee is recovering from his or her injury.
True False

16. Sam was unemployed for the first two months of 2013. During that time, he received $4,000 of state unemployment benefits. He worked for the next six months and earned $14,000. In September, he was injured on the job and collected $5,000 of workers’ compensation benefits. Sam’s Federal gross income from the above is $18,000 ($4,000 + $14,000).
True False

17. Sarah’s employer pays the hospitalization insurance premiums for a policy that covers all employees and retired former employees. After Sarah retires, the hospital insurance premiums paid for her by her employer can be excluded from her gross income.
True False

18. Meg’s employer carries insurance on its employees that will pay an employee his or her regular salary while the employee is away from work due to illness. The premiums for Meg’s coverage were $1,800. Meg was absent from work for two months as a result of a kidney infection. Meg’s employer’s insurance company paid Meg’s regular salary of $8,000 while she was away from work. Meg also collected $2,000 on a wage continuation policy she had purchased. Meg must include $11,800 in her gross income.
True False

19. Melody works for a company with only 22 employees. Her employer contributed $2,000 to her health savings account (HSA), and the account earned $100 in interest during the year. Melody withdrew only $1,200 to pay medical expenses during the year. Melody is not required to recognize any gross income from the HSA for the year.
True False

20. If an employer pays for the employee’s long-term care insurance premiums, the employee can exclude from gross income the premiums but all of the benefits collected must be included in gross income.
True False

21. Employees of a CPA firm located in Virginia may exclude from gross income the meals and lodging provided by the employer while they were on an audit in Texas.
True False

22. Carla is a deputy sheriff. Her employer requires that she live in the county where she is employed. Housing is very expensive; so the county agreed to pay her $4,800 per year to cover the higher cost of housing. Carla must include the housing supplement in her gross income.
True False

23. Roger is in the 35% marginal tax bracket. Roger’s employer has created a flexible spending account for medical and dental expenses that are not covered by the company’s health insurance plan. Roger had his salary reduced by $1,200 during the year for contributions to the flexible spending plan. However, Roger incurred only $1,100 in actual expenses for which he was reimbursed. Under the plan, he must forfeit the $100 unused amount. His after-tax cost of overfunding the plan is $65.
True False

24. Mauve Company permits employees to occasionally use the copying machine for personal purposes. The copying machine is located in the office where the higher paid executives work, so they occasionally use the machine. However, the machine is not convenient for use by the lower paid warehouse employees and, thus, they never use the copier. The use of the copy machine may not be excluded from gross income because the benefit is discriminatory.
True False

25. Fresh Bakery often has unsold donuts at the end of the day. The bakery allows employees to take the leftovers home. The employees are not required to recognize gross income because the bakery does not incur any additional cost.
True False

26. Nicole’s employer pays her $150 per month towards the cost of parking near a railway station where Nicole catches the train to work. The employer also pays the cost of the rail pass, $75 per month. Nicole can exclude both of these payments from her gross income.
True False

27. A U.S. citizen who works in France from February 1, 2013 until January 31, 2014 is eligible for the foreign earned income exclusion in 2013 and 2014.
True False

28. Generally, a U.S. citizen is required to include in gross income the salary and wages earned while working in a foreign country even if the foreign country taxes the income.
True False

29. Calvin miscalculated his income in 2011 and overpaid his state income tax by $10,000. In 2013, he amended his 2011 state income tax return and received a $10,000 refund and $900 interest. Calvin itemized his deductions in 2011, deducting $12,000 in state income tax and $30,000 total itemized deductions. As a result of the amended return in 2013, Calvin must recognize $10,900 of gross income.
True False

30. A cash basis taxpayer took an itemized deduction of $5,500 for state income tax paid in 2013. His total itemized deductions in 2013 were $18,000. In 2014, he received a $900 refund of his 2013 state income tax. The taxpayer must include the $900 refund in his 2014 Federal gross income in accordance with the tax benefit rule.
True False

31. The taxpayer incorrectly took a $5,000 deduction (e.g., incorrectly calculated depreciation) in 2013 and as a result his taxable income was reduced by $5,000. The taxpayer discovered his error in 2014. The taxpayer must add $5,000 to his 2014 gross income in accordance with the tax benefit rule to correct for the 2013 error.
True False

32. Mother participated in a qualified state tuition program for the benefit of her son. She contributed $15,000. When the son entered college, the balance in the fund satisfied the tuition charge of $20,000. When the funds were withdrawn to pay the college tuition for her son, neither Mother nor son must include $5,000 ($20,000 – $15,000) in gross income.
True False

33. The earnings from a qualified state tuition program account are deferred from taxation until they are used for qualified higher education expenses. At that time, the amount taken from the fund must be included in the gross income of the person who contributed to the account.
True False

34. Benny loaned $100,000 to his controlled corporation. When it became apparent the corporation would not be able to repay the loan in the near future, Benny canceled the debt. The corporation should treat the cancellation as a nontaxable contribution to capital.
True False

35. Zork Corporation was very profitable and had accumulated excess cash. The company decided to repurchase some of its bonds that had been issued for $1,000,000. Because of an increase in market interest rates, Zork was able to retire the bonds for $900,000. The company is not required to recognize $100,000 of income from the discharge of its indebtedness but must reduce the basis in its assets.
True False

36. Amber Machinery Company purchased a building from Ted for $250,000 cash and a mortgage of $750,000. One year after the transaction, the mortgage had been reduced to $725,000 by principal payments by Amber, but it was apparent that Amber would not be able to continue to make the monthly payments on the mortgage. Ted reduced the amount owed by Amber to $600,000. This reduced the monthly payments to a level that Amber could pay. Amber must recognize $125,000 income from the reduction in the debt by Ted.
True False

37. The taxpayer’s marginal tax bracket is 25%. Which would the taxpayer prefer?
A. $1.00 taxable income rather than $1.25 tax-exempt income.
B. $1.00 taxable income rather than $.75 tax-exempt income.
C. $1.25 taxable income rather than $1.00 tax-exempt income.
D. $1.40 taxable income rather than $1.00 tax-exempt income.
E. None of the above.

38. Cash received by an individual:
A. Is not included in gross income if it was not earned.
B. Is not taxable unless the payor is legally obligated to make the payment.
C. Must always be included in gross income.
D. May be included in gross income although the payor is not legally obligated to make the payment.
E. None of the above.

39. 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 necklace is a nontaxable gift received by Sharon because the friend was not legally required to make the gift.
B. The value of the necklace is not included in Sharon’s gross income unless she sells it.
C. 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.
D. The value of the necklace must be included in Sharon’s gross income for the tax year it was received by her.
E. None of the above.

40. 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. $0.
B. $2,500.
C. $10,000.
D. $25,000.
E. None of the above.

41. 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. None of the payments must be included in Iris’s gross income.
B. The amount she receives in the first year is a nontaxable return of capital.
C. For each $18,000 payment that Iris receives, she can exclude $500 ($5,000/$180,000 ´ $18,000) from gross income.
D. For each $18,000 payment that Iris receives, she can exclude $15,000 ($150,000/$180,000 ´ $18,000) from gross income.
E. None of the above.

42. 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. 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.
B. Turquoise Company and Rebecca can exclude the life insurance proceeds of $1,500,000 and $100,000, respectively, from 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 the above.

43. 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 $1,500 income from the life insurance proceeds.
B. Must recognize $1,300 income from the life insurance proceeds.
C. Does not recognize income because life insurance proceeds are tax-exempt.
D. Does not recognize income from the life insurance because the entire amount is a recovery of capital.
E. None of the above.

44. 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. Both Ben and Henry must recognize $38,000 ($50,000 – $12,000) of gross income.
C. Henry must recognize $38,000 ($50,000 – $12,000) of gross income, but Ben does not recognize any gross income.
D. Ben must recognize $38,000 ($50,000 – $12,000) of gross income, but Henry does not recognize any gross income.
E. None of the above.

45. 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 $55,000 of gross income, but he has $15,000 of deductible medical expenses.
B. Albert must recognize $65,000 ($80,000 – $15,000) of gross income.
C. Albert must recognize $40,000 ($80,000 – $25,000 – $15,000) of gross income.
D. Albert is not required to recognize any gross income because of his terminal illness.
E. None of the above.

46. A scholarship recipient at State University may exclude from gross income the scholarship proceeds used to pay for:
A. Only tuition.
B. Tuition, books, and supplies.
C. Tuition, books, supplies, meals, and lodging.
D. Meals and lodging.
E. None of the above.

47. Ron, age 19, is a full-time graduate student at City University. During 2013, 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 advisor 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 2013?
A. $1,500.
B. $3,900.
C. $9,000.
D. $15,400.
E. None of the above.

48. 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. $6,300.
C. $11,300.
D. $12,800.
E. None of the above.

49. 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. $10,000.
B. $4,000.
C. $3,000.
D. $500.
E. None of the above.

50. 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 directly to each child’s educational institution and are payable only if the student maintains a B average.
A. The tuition payments of $30,000 may be excluded from Ollie’s gross income as a scholarship.
B. The tuition payments of $10,000 each must be included in the child’s gross income.
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 the above.

51. 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 excludible if the money is used to pay for tuition and books.
B. The $13,500 is taxable compensation.
C. The $13,500 is considered a scholarship and, therefore, is excluded.
D. The $13,500 is excluded because the total amount received for the year is less than her standard deduction and personal exemption.
E. None of the above.

52. In 2013, 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 $20,000 less. ($50,000 + $90,000 + $70,000 – $100,000 – $90,000).
B. Amber’s offer is $7,000 less. [($50,000 + $90,000 + $70,000 – $100,000 – $90,000) ´ .35)].
C. Amber’s offer is $4,500 more. {$190,000 – ($50,000 + $90,000) + [$70,000 ´ (1 – .35)]}.
D. Amber’s offer is $22,000 more. [($190,000 – $210,000) + ($120,000 ´ .35)].
E. None of the above.

53. Christie sued her former employer for a back injury she suffered on the job in 2013. As a result of the injury, she was partially disabled. In 2014, 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 2013 return, reducing her taxable income by $12,000. Christie’s 2014 gross income from the above is:
A. $415,000.
B. $412,000.
C. $255,000.
D. $175,000.
E. $172,000.

54. 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. $25,000.
B. $15,000.
C. $12,500.
D. $10,000.
E. $0.

55. 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. $700,000.
B. $500,000.
C. $490,000 [($700,000/$1,000,000) ´ $700,000].
D. $0.
E. None of the above.

56. 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. $0.
B. $100,000.
C. $120,000.
D. $270,000.
E. None of the above.

57. Olaf was injured in an automobile accident and received $25,000 for his physical injury, $50,000 for his loss of income, and $10,000 punitive damages. As a result of the award, the amount Olaf must include in gross income is:
A. $10,000.
B. $50,000.
C. $60,000.
D. $85,000.
E. None of the above.

58. The exclusion for health insurance premiums paid by the employer applies to:
A. Only current employees and their spouses.
B. Only current employees and their spouses and dependents.
C. Only current employees and their disabled spouses.
D. Present employees, retired former employees, and their spouses and dependents.
E. None of the above.

59. Julie was suffering from a viral infection that caused her to miss work for 90 days. During the first 30 days of her absence, she received her regular salary of $8,000 from her employer. For the next 60 days, she received $12,000 under an accident and health insurance policy purchased by her employer. The premiums on the health insurance policy were excluded from her gross income. During the last 30 days, Julie received $6,000 on an income replacement policy she had purchased. Of the $26,000 she received, Julie must include in gross income:
A. $0.
B. $6,000.
C. $8,000.
D. $14,000.
E. $20,000.

60. Matilda works for a company with 1,000 employees. The company has a hospitalization insurance plan that covers all employees. However, the employee must pay the first $3,000 of his or her medical expenses each year. Each year, the employer contributes $1,500 to each employee’s health savings account (HSA). Matilda’s employer made the contributions in 2012 and 2013, and the account earned $100 interest in 2013. At the end of 2013, Matilda withdrew $3,100 from the account to pay the deductible portion of her medical expenses for the year and other medical expenses not covered by the hospitalization insurance policy. As a result, Matilda must include in her 2013 gross income:
A. $0.
B. $100.
C. $1,600.
D. $3,100.
E. None of the above.

61. All employees of United Company are covered by a group hospitalization insurance plan, but the employees must pay the premiums ($8,000 for each employee). None of the employees has sufficient medical expenses to deduct the premiums. Instead of giving raises next year, United is considering paying the employee’s hospitalization insurance premiums. If the change is made, the employee’s after-tax and insurance pay will:
A. Decrease by the same amount for all employees.
B. Increase more for the lower paid employees (10% and 15% marginal tax bracket).
C. Increase more for the higher income (35% marginal tax bracket) employees.
D. Increase by the same amount for all employees.
E. None of the above.

62. The plant union is negotiating with the Eagle Company, which is on the verge of bankruptcy. Eagle has offered to pay for the employees’ hospitalization insurance in exchange for a wage reduction. The employees each currently pay premiums of $4,000 a year for their insurance.
A. If an employee’s wages are reduced by $5,000 and the employee is in the 28% marginal tax bracket, the employee would benefit from the offer.
B. If an employee’s wages are reduced by $4,000 and the employee is in the 15% marginal tax bracket, the employee would benefit from the offer.
C. If an employee’s wages are reduced by $6,000 and the employee is in the 35% marginal tax bracket, the employee would benefit from the offer.
D. a., b., and c.
E. None of the above.

63. James, a cash basis taxpayer, received the following compensation and fringe benefits in 2013:

Salary	$66,000
Disability income protection premiums	3,000
Long-term care insurance premiums	4,000

His actual salary was $72,000. He received only $66,000 because his salary was garnished and the employer paid $6,000 on James’s credit card debt he owed. The wage continuation insurance is available to all employees and pays the employee three-fourths of the regular salary if the employee is sick or disabled. The long-term care insurance is available to all employees and pays $150 per day towards a nursing home or similar facility. What is James’s gross income from the above?
A. $66,000.
B. $72,000.
C. $73,000.
D. $75,000.
E. None of the above.

64. The First Chance Casino has gambling facilities, a bar, a restaurant, and a hotel. All employees are allowed to obtain food from the restaurant at no charge during working hours. In the case of the employees who operate the gambling facilities, bar, and restaurant, 60% of all of Casino’s employees, the meals are provided for the convenience of the Casino. However, the hotel workers, demanded equal treatment and therefore were also allowed to eat in the restaurant at no charge while they are at work. Which of the following is correct?
A. All the employees are required to include the value of the meals in their gross income.
B. Only the restaurant employees may exclude the value of their meals from gross income.
C. Only the employees who work in gambling, the bar, and the restaurant may exclude the meals from gross income.
D. All of the employees may exclude the value of the meals from gross income.
E. None of the above.

65. An employee can exclude from gross income the value of meals provided by his or her employer whenever:
A. The meal is not extravagant.
B. The meals are provided on the employer’s premises for the employer’s convenience.
C. There are no places to eat near the work location.
D. The meals are provided for the convenience of the employee.
E. None of the above.

66. Ridge is the manager of a motel. As a condition of his employment, Ridge is required to live in a room on the premises so that he would be there in case of emergencies. Ridge considered this a fringe benefit, since he would otherwise be required to pay $800 per month rent. The room that Ridge occupied normally rented for $70 per night, or $2,100 per month. On the average, 90% of the motel rooms were occupied. As a result of this rent-free use of a room, Ridge is required to include in gross income.
A. $0.
B. $800 per month.
C. $2,100 per month.
D. $1,890 ($2,100 ´ .90).
E. None of the above.

67. Adam repairs power lines for the Egret Utilities Company. He is generally working on a power line during the lunch hour. He must eat when and where he can and still get his work done. He usually purchases something at a convenience store and eats in his truck. Egret reimburses Adam for the cost of his meals.
A. Adam must include the reimbursement in his gross income.
B. Adam can exclude the reimbursement from his gross income since the meals are provided for the convenience of the employer.
C. Adam can exclude the reimbursement from his gross income because he eats the meals on the employer’s business premises (the truck).
D. Adam may exclude from his gross income the difference between what he paid for the meals and what it would have cost him to eat at home.
E. None of the above.

68. Tommy, a senior at State College, receives free room and board as full compensation for working as a resident advisor at the university dormitory. The regular housing contract is $2,000 a year in total, $1,200 for lodging and $800 for meals in the dormitory. Tommy had the option of receiving the meals or $800 in cash. Tommy accepted the meals. What must Tommy include in gross income from working as a resident advisor?
A. All items can be excluded from gross income as a scholarship.
B. The meals must be included in gross income.
C. The meals may be excluded because he did not receive cash.
D. The lodging must be included in gross income because it was compensation for services.
E. None of the above.

69. Under the Swan Company’s cafeteria plan, all full-time employees are allowed to select any combination of the benefits below, but the total received by the employee cannot exceed $8,000 a year.

I.	Group medical and hospitalization insurance for the employee, $3,600 a year.
II.	Group medical and hospitalization insurance for the employee’s spouse and children, $1,200 a year.
III.	Child-care payments, actual cost but not more than $4,800 a year.
IV.	Cash required to bring the total of benefits and cash to $8,000.

Which of the following statements is true?
A. Sam, a full-time employee, selects choices II and III and $2,000 cash. His gross income must include the $2,000.
B. Paul, a full-time employee, elects to receive $8,000 cash because his wife’s employer provided these same insurance benefits for him. Paul is required to include the $8,000 in gross income.
C. Sue, a full-time employee, elects to receive choices I, II and $3,200 for III. Sue is required to include $3,200 in gross income.
D. All of the above.
E. None of the above.

70. Heather is a full-time employee of the Drake Company and participates in the company’s flexible spending plan that is available to all employees. Which of the following is correct?
A. Heather reduced her salary by $1,200, actually spent $1,500, and received only $1,200 as reimbursement for her medical expenses. Heather’s gross income will be reduced by $1,500.
B. Heather reduced her salary by $1,200, and received only $900 as reimbursement for her actual medical expenses. She is not refunded the $300 remaining balance, but her gross income is reduced by $1,200.
C. Heather reduced her salary by $1,200, and received only $800 as reimbursement for her medical expenses. She is not refunded the $400. Her gross income is reduced by $800.
D. Heather reduced her salary by $1,200, and received only $900 as reimbursement for her medical expenses. She forfeits the $300. Her gross income is reduced by $300.
E. None of the above.

71. Employees of the Valley Country Club are allowed to use the golf course without charge before and after working hours on Mondays, when the number of players on the course is at its lowest. Tom, an employee of the country club played 40 rounds of golf during the year at no charge when the non-employee charge was $20 per round.
A. Tom must include $800 in gross income.
B. Tom is not required to include anything in gross income because it is a de minimis fringe benefit.
C. Tom is not required to include the $800 in gross income because the use of the course was a gift.
D. Tom is not required to include anything in gross income because this is a “no-additional-cost service” fringe benefit.
E. None of the above.

72. The Royal Motor Company manufactures automobiles. Employees of the company can buy a new automobile for Royal’s cost plus 2%. The automobiles are sold to dealers at cost plus 20%. Generally, employees of Local Dealer, Inc., are allowed to buy a new automobile from the company at the dealer’s cost. Officers of Local Dealer are allowed to use a company vehicle (for personal use) at no cost.
A. The employees who buy automobiles at a discount are not required to recognize income from the purchase.
B. None of the employees who take advantage of the fringe benefits described above are required to recognize income.
C. Employees of Royal are required to recognize as gross income 18% (20% – 2%) of the cost of the automobile purchased.
D. All employees must recognize gross income from their personal use of the company vehicles.
E. None of the above.

73. Peggy is an executive for the Tan Furniture Manufacturing Company. Peggy purchased furniture from the company for $9,500, the price Tan ordinarily would charge a wholesaler for the same items. The retail price of the furniture was $12,500, and Tan’s cost was $9,000. The company also paid for Peggy’s parking space in a garage near the office. The parking fee was $600 for the year. All employees are allowed to buy furniture at a discounted price comparable to that charged to Peggy. However, the company does not pay other employees’ parking fees. Peggy’s gross income from the above is:
A. $0.
B. $600.
C. $3,500.
D. $4,100.
E. None of the above.

74. The employees of Mauve Accounting Services are permitted to use the copy machine for personal purposes, provided the privilege is not abused. Ed is the president of a civic organization and uses the copier to make several copies of the organization’s agenda for its meetings. The copies made during the year would have cost $150 at a local office supply.
A. Ed must include $150 in his gross income.
B. Ed may exclude the cost of the copies as a no-additional cost fringe benefit.
C. Ed may exclude the cost of the copies only if the organization is a client of Mauve.
D. Ed may exclude the cost of the copies as a de minimis fringe benefit.
E. None of the above.

75. The Perfection Tax Service gives employees $12.50 as “supper money” when they are required to work overtime, approximately 25 days each year. The supper money received:
A. Must be included in the employee’s gross income.
B. Must be included in the employee’s gross income if the employee does not spend it for supper.
C. May be excluded from the employee’s gross income as a “no-additional cost” fringe benefit.
D. May be excluded from the employee’s gross income as a de minimis fringe benefit.
E. None of the above.

76. The de minimis fringe benefit:
A. Exclusion applies only to property received by the employee.
B. Can be provided on a discriminatory basis.
C. Exclusion is limited to $250 per year.
D. Exclusion applies to employee discounts.
E. None of the above.

77. Evaluate the following statements:

I.	De minimis fringe benefits are those that are so immaterial that accounting for them is impractical.
II.	De minimis fringe benefits are subject to strict anti-discrimination requirements.
III.	Generally, a fringe benefit of less than $50 is considered de minimis and can be excluded from gross income.

A. Only I is true.
B. Only III is true.
C. Only I and III are true.
D. I, II, and III are true.
E. None of the above.

78. Kristen’s employer owns its building and provides parking space for its employees. The value of the free parking is $150 per month. Karen’s employer does not have parking facilities, but reimburses its employee for the cost of parking in a nearby garage, up to $150 per month.
A. Kristen and Karen must recognize gross income from the parking services.
B. Kristen can exclude the employer provided parking from gross income, but Karen must include her reimbursement in gross income.
C. Kristen must include the value of the employer provided parking from her gross income, but Karen can exclude her reimbursement from gross income.
D. Neither Kristen nor Karen is required to include the cost of parking in gross income.
E. None of the above.

79. A company has a medical reimbursement plan for officers that covers all costs that the insurer will not pay. However, for all employees who are not officers, the medical reimbursement plan applies only after the employee has paid $1,000 from his or her own funds. An officer incurred $1,500 in medical expenses and was reimbursed for that amount. An hourly worker also incurred $1,500 in medical expense and was reimbursed $500.
A. Both employees must include all benefits received in gross income.
B. The officer must include $500 in gross income.
C. The officer must include $1,500 in gross income.
D. The hourly employee must include $1,000 in gross income.
E. None of the above.

80. A U.S. citizen worked in a foreign country for the period July 1, 2012 through August 1, 2013. Her salary was $10,000 per month. Also, in 2012 she received $5,000 in dividends from foreign corporations (not qualified dividends). No dividends were received in 2013. Which of the following is correct?
A. The taxpayer cannot exclude any of the income because she was not present in the foreign country more than 330 days in either 2012 or 2013.
B. The taxpayer can exclude a portion of the salary from U.S. gross income in 2012 and 2013, and all of the dividend income.
C. The taxpayer can exclude from U.S. gross income $60,000 salary in 2012, but in 2013 the taxpayer will exceed the twelve month limitation and, therefore, all of the 2013 compensation must be included in gross income. All of the dividends must be included in 2012 gross income.
D. The taxpayer must include the dividend income of $5,000 in 2012 gross income, but the taxpayer can exclude a portion of the compensation income from U.S. gross income in 2012 and 2013.
E. None of the above.

81. Louise works in a foreign branch of her employer’s business. She earned $5,000 per month throughout the relevant period.
A. If Louise worked in the foreign branch from May 1, 2012 until October 31, 2013, she may exclude $40,000 from gross income in 2012 and exclude $50,000 in 2013.
B. If Louise worked in the foreign branch from May 1, 2012 until October 31, 2013, she cannot exclude anything from gross income because she was not present in the country for 330 days in either year.
C. If Louise began work in the foreign country on May 1, 2012, she must work through November 30, 2013 in order to exclude $55,000 from gross income in 2013 but none in 2012.
D. Louise will not be allowed to exclude any foreign earned income because she made less than $97,600.
E. None of the above.

82. In the case of interest income from state and Federal bonds:
A. Interest on United States government bonds received by a state resident can be subject to that state’s income tax.
B. Interest on United States government bonds is subject to Federal income tax.
C. Interest on bonds issued by State A received by a resident of State B cannot be subject to income tax in State B.
D. All of the above are correct.
E. None of the above are correct.

83. Heather’s interest and gains on investments for 2013 were as follows:

Interest on Bland County school bonds	$600
Interest on U.S. government bonds	700
Interest on a Federal income tax refund	200
Gain on the sale of Bland County school bonds	500

Heather’s gross income from the above is:
A. $2,000.
B. $1,800.
C. $1,400.
D. $1,300.
E. None of the above.

84. Emily is in the 35% marginal tax bracket. She can purchase a York County school bond yielding 3.5% interest and the interest is not subject to a 5% state tax. But she is interested in earning a higher return for comparable risk.
A. If she buys a corporate bond that pays 6% interest, her after-tax rate of return will be less than if she purchased the York County school bond.
B. If she buys a U.S. government bond paying 5%, her after-tax rate of return will be less than if she purchased the York County school bond.
C. If she buys a common stock paying a 4% dividend, her after-tax rate of return will be higher than if she purchased the York County school bond.
D. All of the above are correct.
E. None of the above are correct.

85. Doug and Pattie received the following interest income in the current year:

Savings account at Greenbacks Bank	$4,000
United States Treasury bonds	250
Interest on State of Virginia bonds	200
Interest on Federal tax refund	150
Interest on state income tax refund	75

Greenbacks Bank also gave Doug and Pattie a cellular phone (worth $100) for opening the savings account. What amount of interest income should they report on their joint income tax return?
A. $4,775.
B. $4,675.
C. $4,575.
D. $4,300.
E. None of the above.

86. George, an unmarried cash basis taxpayer, received the following amounts during 2013:

Interest on savings accounts	$2,000
Interest on a State tax refund	600
Interest on City of Salem school bonds	350
Interest portion of proceeds of a 5% bank certificate of deposit purchased on July 1, 2012, and matured on June 30, 2013	250
Dividends on USG common stock	300

What amount should George report as gross income from dividends and interest for 2013?
A. $2,300.
B. $2,550.
C. $3,150.
D. $3,500.
E. None of the above.

87. Stuart owns 300 shares of Turquoise Corporation stock and 2,000 shares of Blue Corporation stock. During the year, Stuart received 150 shares of Turquoise as a result of a 1 for 2 stock split. The value of the shares received was $4,800. Stuart also received 100 shares of Blue Corporation stock as a result of a 5% stock dividend. Stuart did not have the option of receiving cash from Blue. The additional shares he received had a value of $7,200. Stuart’s gross income from the receipt of the additional Turquoise and Blue shares is:
A. $0.
B. $4,800.
C. $7,200.
D. $12,000.
E. None of the above.

88. Assuming a taxpayer qualifies for the exclusion treatment, the interest income on educational savings bonds:
A. Is gross income to the person who purchased the bond in the year the interest is earned.
B. Is gross income to the student in the year the interest is earned.
C. Is included in the student’s gross income in the year the savings bonds are sold or redeemed to pay educational expenses.
D. Is not included in anyone’s gross income if the proceeds are used to pay college tuition.
E. None of the above.

89. The exclusion of interest on educational savings bonds:
A. Applies only to savings bonds owned by the child.
B. Applies to parents who purchase bonds for which the proceeds are used for their child’s education.
C. Means that the child must include the interest in income if the bond is owned by the parent.
D. Does apply even if used to pay for room and board.
E. None of the above.

90. Martha participated in a qualified tuition program for the benefit of her son. She invested $6,000 in the fund. Four years later her son withdrew $8,000, the entire balance in the program, to pay his college tuition.
A. Martha is not required to include the $2,000 ($8,000 – $6,000) in her gross income when the funds are used to pay the tuition.
B. Martha’s son must include the $2,000 ($8,000 – $6,000) in his gross income when the funds are used to pay the tuition.
C. Martha must include $8,000 in her gross income.
D. Martha’s son must include $8,000 in his gross income.
E. None of the above.

91. In December 2013, Todd, a cash basis taxpayer, paid $1,200 of fire insurance premiums for the calendar year 2014 on a building he held for rental income. Todd deducted the $1,200 of insurance premiums on his 2013 tax return. He had $150,000 of taxable income that year. On June 30, 2014, he sold the building and, as a result, received a $500 refund on his fire insurance premiums. As a result of the above:
A. Todd should amend his 2013 return and claim $500 less insurance expense.
B. Todd should include the $500 in 2014 gross income in accordance with the tax benefit rule.
C. Todd should add the $500 to his sales proceeds from the building.
D. Todd should include the $500 in 2014 gross income in accordance with the claim of right doctrine.
E. None of the above.

92. Tonya is a cash basis taxpayer. In 2013, she paid state income taxes of $8,000. In early 2014, she filed her 2013 state income tax return and received a $900 refund.
A. If Tonya itemized her deductions in 2013 on her Federal income tax return, she should amend her 2013 return and reduce her itemized deductions by $900.
B. If Tonya itemized her deductions in 2013 on her Federal income tax return and her itemized deductions exceeded the standard deduction by at least $900, the refund will not affect her 2014 tax return.
C. If Tonya itemized her deductions in 2013 on her Federal income tax return, she must amend her 2013 Federal income tax return and use the standard deduction.
D. If Tonya itemized her deductions in 2013 on her Federal income tax return and her itemized deductions exceeded the standard deduction by more than $900, she must recognize $900 income in 2014 under the tax benefit rule.
E. None of the above.

93. Harold bought land from Jewel for $150,000. Harold paid $50,000 cash and gave Jewel an 8% note for $100,000. The note was to be paid over a five-year period. When the balance on the note was $80,000, Jewel began having financial difficulties. To accelerate her cash inflows, Jewel agreed to accept $60,000 cash from Harold in final payment of the note principal.
A. Harold must recognize $20,000 ($80,000 – $60,000) of gross income.
B. Harold is not required to recognize gross income, but must reduce his cost basis in the land to $130,000.
C. Harold is not required to recognize gross income, since he paid the debt before it was due.
D. Jewel must recognize gross income of $20,000 ($80,000 – $60,000) from discharge of the debt.
E. None of the above.

94. Hazel, a solvent individual but a recovering alcoholic, embezzled $6,000 from her employer. In the same year that she embezzled the funds, her employer discovered the theft. Her employer did not fire her and told her she did not have to repay the $6,000 if she would attend Alcoholics Anonymous. Hazel met the conditions and her employer canceled the debt.
A. Hazel did not realize any income because her employer made a gift to her.
B. Hazel must include $6,000 in gross income from discharge of indebtedness.
C. Hazel must include $6,000 in gross income under the tax benefit rule.
D. Hazel may exclude the $6,000 from gross income because the debt never existed.
E. None of the above.

95. Gold Company was experiencing financial difficulties, but was not bankrupt or insolvent. The National Bank, which held a mortgage on other real estate owned by Gold, reduced the principal from $110,000 to $85,000. The bank had made the loan to Gold when it purchased the real estate from Silver, Inc. Pink, Inc., the holder of a mortgage on Gold’s building, agreed to accept $40,000 in full payment of the $55,000 due. Pink had sold the building to Gold for $150,000 that was to be paid in installments over 8 years. As a result of the above, Gold must:
A. Include $40,000 in gross income.
B. Reduce the basis in its assets by $40,000.
C. Include $25,000 in gross income and reduce its basis in its assets by $15,000.
D. Include $15,000 in gross income and reduce its basis in the building by $25,000.
E. None of the above.

96. On January 1, 2003, Cardinal Corporation issued 5% 25-year bonds at par and used the $12,000,000 proceeds to finance the construction of a new plant. On January 1, 2013, the company acquired the bonds on the open market for $11,500,000. Assuming that Cardinal Corporation is neither bankrupt nor insolvent, the acquisition and retirement of the bonds results in which of the following:
A. The company must recognize a $500,000 gain.
B. The company can make an election to recognize a $500,000 gain or reduce the company’s basis in the plant by $500,000.
C. The company must recognize a $500,000 gain and increase the company’s basis in the plant by $500,000.
D. The company can amortize the $500,000 gain, recognizing income over the remaining life of the bonds.
E. None of the above.

97. Denny was neither bankrupt nor insolvent but was short of cash and could not make the mortgage payments on his personal residence in 2013. The bank that held the mortgage agreed to reduce the principal on the debt from $100,000 to $80,000 so that Denny’s monthly mortgage payments could be reduced to a manageable amount. Denny also had a vacation home with a mortgage whose payments were beyond his means. The mortgage holder on the vacation home agreed to reduce the mortgage from $60,000 to $50,000. The value of the personal residence was $80,000 and the value of the vacation home was $45,000 at the dates of the debt reduction.
A. Denny is not required to recognize any income as a result of the reduction in the principal of the mortgages.
B. Denny is required to recognize $10,000 income from the reduction in the mortgage on the vacation home, but has no gross income from the reduction in the mortgage principal on his personal residence.
C. Denny is required to recognize $5,000 income from the reduction in the mortgage on the vacation home, but nothing for the reduction in the mortgage on his personal residence.
D. Denny is required to recognize $10,000 income from the reduction in the mortgage on the vacation home and $20,000 income for the reduction in the mortgage on his personal residence.
E. None of the above.

98. Flora Company owed $95,000, a debt incurred to purchase land that serves as security for the debt.
A. If Flora had borrowed the funds from a bank, the bank accepts $85,000 in full payment of the debt, and Flora is solvent after the transfer, Flora does not recognize income, but the company must reduce the cost of the land by $10,000.
B. If Flora had borrowed the funds from a bank, and the bank accepts $85,000 in full payment of the debt, when the value of the property is $80,000, Flora can deduct a loss.
C. If Flora transfers to the bank other property, with a basis of $90,000 and a fair market value of $95,000, in full payment of the debt, Flora can recognize a $5,000 loss.
D. If the $95,000 is owed to the person who sold the property to Flora, and the creditor accepts $85,000 in full payment for the debt, Flora does not recognize gain but must reduce its basis in the land.
E. None of the above.

99. Sandy is married, files a joint return, and expects to be in the 28% marginal tax bracket for the foreseeable future. All of his income is from salary and all of it is used to maintain the household. He has a paid-up life insurance policy with a cash surrender value of $100,000. He paid $60,000 of premiums on the policy. His gain from cashing in the life insurance policy would be ordinary income. If he retains the policy, the insurance company will pay him $3,000 (3%) interest each year. Sandy thinks he can earn a higher return if he cashes in the policy and invests the proceeds.

a.	What before-tax rate of return would Sandy be required to earn on the proceeds from cashing in the policy to equal the return earned with the insurance company?
b.	Assume Sandy estimates he can earn a 6% before-tax rate of return on the proceeds from cashing in the policy. Assume he can earn a 6% return for the remainder of his life and that he will reinvest all earnings at the same 6% before-tax rate of return. If Sandy expects to live 10 more years, which alternative will yield the greater amount to his beneficiaries upon Sandy’s death? (Given: The future value of an annuity in 10 years assuming a 4.32% after-tax return is 12.19. The future value of an annuity in 10 years assuming a 2.16% return is 11.03).

100. Beverly died during the current year. At the time of her death, her accrued salary and commissions totaled $3,000 and were paid to her husband. The employer also paid the husband $35,000 which represented an amount equal to Beverly’s salary for the year prior to her death. The employer had a policy of making the salary payments to “help out the family in the time of its greatest need.” Beverly’s spouse collected her interest in the employer’s qualified profit sharing plan amounting to $30,000. As beneficiary of his wife’s life insurance policy, Beverly’s spouse elected to collect the proceeds in installments. In the year of death, he collected $8,000 which included $1,500 interest income. Which of these items are subject to income tax for Beverly’s spouse?

101. Barbara was injured in an automobile accident. She has threatened to file a suit against the other party involved in the accident and has proposed the following settlement:

Damages for 25% loss of the use of her right arm	$200,000
Medical expenses	30,000
Loss of wages	10,000
Punitive damages	100,000
	$340,000

The defendant’s insurance company is reluctant to pay punitive damages. Also, the company disputes the amount of her loss of wages amount. Instead, the company offers to pay her $300,000 for damages to her arm and $30,000 medical expenses. Assuming Barbara is in the 35% marginal tax bracket, will her after-tax proceeds from accepting the offer be equal to what she considers to be her actual damages (listed above)?

102. George is employed by the Quality Appliance Company. All the full time employees are allowed to purchase appliances at the company’s cost plus 10%. The employee also is given, at no cost, a 1-year service contract on all the goods purchased from the company. George purchased a refrigerator for $500. The company’s normal selling price for the refrigerator is $800. George also received a service contract, at no charge, that had a value of $150. During the year, George was required to have his refrigerator serviced once. The cost of the call would have been $75 if he had not had the service contract. Is George required to recognize any income from the purchase of the refrigerator, the receipt of the service contract, and the service call?

103. Sonja is a United States citizen who has worked in Spain for the past 10 months. She received $8,000 a month as compensation. Her employer has offered to extend Sonja’s contract to work in Spain for another 6 months at the same rate of pay. If she rejects the offer, she can return to the United States and receive a salary of $10,000 per month. While working in Spain, she is subject to the Spain income tax, which is approximately 11% of her gross pay. The marginal tax rate on her income taxed in the United States is 25%. Compare Sonja’s after-tax income assuming she remains in Spain with her after-tax income if she returns to the United States.

104. Juan, was considering purchasing an interest in a tax-exempt bond fund for $100,000, when he discovered that the interest must be included on his state income tax return. The interest rate is 5%. His marginal Federal tax rate is 35%, and his marginal state income tax rate is 10%. Juan itemizes his deductions on his Federal income tax return. As an alternative, Juan can purchase a state bond (a “double-exempt bond”) yielding 4.9% interest that is exempt from both Federal and state income tax. Which investment would yield the greater after-tax return?

105. Margaret is trying to decide whether to place funds in a qualified tuition program. Her son will be attending college in 4 years. She is in the 35% marginal tax bracket and she believes she can earn an 7% before tax return on alternative investments. Thus, $10,000 will accumulate to $11,948 (after-tax) in 4 years. Margaret expects tuition to increase at the rate of 5% each year to $12,155 in 4 years. Her son will be in the 15% marginal tax bracket in all relevant years. Given these assumptions, should Margaret participate in the qualified tuition program?

106. Gull Corporation was undergoing reorganization under the bankruptcy laws. The shareholders, who had made loans of $300,000 to the corporation, agreed to accept additional stock with a value of $200,000 instead of repayment on the debt. The Old Line Insurance Company, which had a $400,000 mortgage on the building, agreed to reduce the principal to $250,000. A trade creditor with a receivable of $150,000 from the company agreed to accept $70,000 in full payment for the debt incurred to purchase goods that were still on hand. Finally, the company transferred some equipment with an adjusted basis of $90,000 in satisfaction of a liability for $120,000. Compute the corporation’s gross income and other adjustments necessary as a result of the above transactions.

107. Carmen had worked for Sparrow Corporation for thirty years when she died of a heart attack at age 60. She was practically penniless at the time of her death, owed a $12,000 hospital bill, and had a disabled spouse. The company was very concerned about its public image, and rather than run the risk of embarrassment from one of its long-term employees dying and leaving her spouse with insufficient means, the Board of Directors agreed to pay Carmen’s hospital bill and to give her spouse $6,000 per year for the rest of his life. Discuss both sides of the question whether Carmen (or her estate) and her spouse realize any taxable income from the above.

108. What are the tax problems associated with payments received by a wife from her deceased husband’s employer? (Assume the wife renders no services to the employer.)

109. Bob had a terminal illness and realized that he “can’t take it with him.” Therefore, he cashed in his insurance policy and received $120,000. He had paid $50,000 in premiums on the policy. He used the money to fulfill his lifelong ambitions of going to the Super Bowl, driving an expensive sports car, and vacationing in Bermuda.

Was Bob’s behavior consistent with the Congressional intent in providing the tax exemption he was permitted to use?

110. Ben was hospitalized for back problems. While he was away from the job, he collected his regular salary from an employer-sponsored income protection insurance policy. Ben’s employer-sponsored hospitalization insurance policy also paid for 90% of his medical expenses. Ben also collected on an income protection policy that he purchased. Which of the above sources of income are taxable? Explain the basis for excluding any item or items.

111. The CEO of Cirtronics Inc., discovered that the company’s competitor had adopted a cafeteria plan for its employees. The CEO is concerned about retaining his talented employees and would like you to provide a brief explanation as to why a cafeteria plan may be attractive to the company’s employees.

112. What Federal income tax benefits are provided for college students?

113. The taxpayer was in the 35% marginal tax bracket in 2013 and deducted $15,000 in state income taxes as an itemized deduction that year. In 2014, he filed his 2013 state income tax return and received a $5,000 refund of state income taxes paid in 2013. His marginal tax rate in 2013 was 15%. What was the taxpayer’s Federal tax benefit from the overpayment of his 2013 state income tax?

114. Employers can provide numerous benefits to their employees and the employees are permitted to exclude the value of these benefits from gross income. What are the effects of the exclusions on:

a.	The progressiveness of the tax system?
b.	The complexity of the tax system?

115. Sally and Ed each own property with a fair market value less than the amount of the outstanding mortgage on the property and also less than the original cost basis. They each were able to convince the mortgage holder to reduce the principal amount on the mortgage. Sally’s mortgage is on her personal residence and Ed’s mortgage is on rental property he owns.

a.	Explain whether each of these individuals has realized income from the reduction in the debt.
b.	Assume that under the current system of measuring income, each of these taxpayers realized income from the reductions in the mortgages. Should either of these taxpayers be permitted to exclude any of the debt reduction income?

116. If a tax-exempt bond will yield approximately .65 (1 – .35) times the yield on a taxable bond of equal risk, who benefits from the tax exemption: the Federal government, the state and local governments who issue the bonds, or the investors?

COMPREHENSIVE VOLUME–CHAPTER 5–GROSS INCOME: EXCLUSIONS Key
1. For a person who is in the 35% marginal tax bracket, $1,000 of tax-exempt income is equivalent to $1,350 of income that is subject to tax.
FALSE

10. If a scholarship does not satisfy the requirements for a gift, the scholarship must be included in gross income.
FALSE

13. Betty received a graduate teaching assistantship that was awarded on the basis of academic achievement. The payments must be included in her gross income.
TRUE

15. Workers’ compensation benefits are included in gross income if the employer also pays the employee while the employee is recovering from his or her injury.
FALSE

21. Employees of a CPA firm located in Virginia may exclude from gross income the meals and lodging provided by the employer while they were on an audit in Texas.
FALSE

27. A U.S. citizen who works in France from February 1, 2013 until January 31, 2014 is eligible for the foreign earned income exclusion in 2013 and 2014.
TRUE

28. Generally, a U.S. citizen is required to include in gross income the salary and wages earned while working in a foreign country even if the foreign country taxes the income.
FALSE

47. Ron, age 19, is a full-time graduate student at City University. During 2013, 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

54. 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. $25,000.
B. $15,000.
C. $12,500.
D. $10,000.
E. $0.

63. James, a cash basis taxpayer, received the following compensation and fringe benefits in 2013:

Salary	$66,000
Disability income protection premiums	3,000
Long-term care insurance premiums	4,000

69. Under the Swan Company’s cafeteria plan, all full-time employees are allowed to select any combination of the benefits below, but the total received by the employee cannot exceed $8,000 a year.

I.	Group medical and hospitalization insurance for the employee, $3,600 a year.
II.	Group medical and hospitalization insurance for the employee’s spouse and children, $1,200 a year.
III.	Child-care payments, actual cost but not more than $4,800 a year.
IV.	Cash required to bring the total of benefits and cash to $8,000.

77. Evaluate the following statements:

I.	De minimis fringe benefits are those that are so immaterial that accounting for them is impractical.
II.	De minimis fringe benefits are subject to strict anti-discrimination requirements.
III.	Generally, a fringe benefit of less than $50 is considered de minimis and can be excluded from gross income.

A. Only I is true.
B. Only III is true.
C. Only I and III are true.
D. I, II, and III are true.
E. None of the above.

83. Heather’s interest and gains on investments for 2013 were as follows:

Interest on Bland County school bonds	$600
Interest on U.S. government bonds	700
Interest on a Federal income tax refund	200
Gain on the sale of Bland County school bonds	500

Heather’s gross income from the above is:
A. $2,000.
B. $1,800.
C. $1,400.
D. $1,300.
E. None of the above.

85. Doug and Pattie received the following interest income in the current year:

Savings account at Greenbacks Bank	$4,000
United States Treasury bonds	250
Interest on State of Virginia bonds	200
Interest on Federal tax refund	150
Interest on state income tax refund	75

86. George, an unmarried cash basis taxpayer, received the following amounts during 2013:

Interest on savings accounts	$2,000
Interest on a State tax refund	600
Interest on City of Salem school bonds	350
Interest portion of proceeds of a 5% bank certificate of deposit purchased on July 1, 2012, and matured on June 30, 2013	250
Dividends on USG common stock	300

What amount should George report as gross income from dividends and interest for 2013?
A. $2,300.
B. $2,550.
C. $3,150.
D. $3,500.
E. None of the above.

a.	What before-tax rate of return would Sandy be required to earn on the proceeds from cashing in the policy to equal the return earned with the insurance company?
b.	Assume Sandy estimates he can earn a 6% before-tax rate of return on the proceeds from cashing in the policy. Assume he can earn a 6% return for the remainder of his life and that he will reinvest all earnings at the same 6% before-tax rate of return. If Sandy expects to live 10 more years, which alternative will yield the greater amount to his beneficiaries upon Sandy’s death? (Given: The future value of an annuity in 10 years assuming a 4.32% after-tax return is 12.19. The future value of an annuity in 10 years assuming a 2.16% return is 11.03).

a.	If Sandy cashes in the policy, he must recognize a $40,000 gain and pay taxes of $11,200 [.28($100,000 – $60,000) = $11,200]. Therefore, he will have only $88,800 to invest ($100,000 – $11,200 = $88,800). To earn $3,000, the same as he receives from the insurance company, Sandy must earn a .03378 return on the after-tax proceeds ($88,800 ´ .03378 = $3,000).

b.	The life insurance proceeds will be exempt from income tax. Therefore, if Sandy retains the policy, the beneficiaries receive $100,000 plus the compound amount of (1 – .28)($3,000) = $2,160 interest earned each year. The interest will be reinvested at 6% before tax, or (1. – .28)(.06) = 4.32% after-tax interest. Given the compound interest factor of 12.19, the annual income will accumulate to 12.19 ´ $2,160 = $26,330. The after-tax policy proceeds are $100,000. Therefore, if Sandy retains the policy, his beneficiaries would expect to receive $126,330 ($100,000 + $26,330). If Sandy cashed in the policy, his beneficiaries will receive the after-tax amount of the policy, as computed in a., above, of $88,800, plus the compound amount of the earnings on the $88,800, at a 4.32% after-tax return. The annual after-tax earnings on $88,800 is $3,836 (.0432 ´ $88,800). This will accumulate to $3,836 ´ 12.19 = $46,761 in 10 years. Therefore, his beneficiaries would receive $135,561 ($88,800 + $46,761). Cashing in the policy is the better alternative.

Salary and commissions	$ 3,000
Profit sharing plan	30,000
Interest income	1,500
Included in gross income	$34,500

All nonforfeitable rights to funds are includible in income (salary, commissions). This includes the accrued salary of $3,000. The collection of Beverly’s interest in the profit sharing plan of $30,000 is subject to taxation. The $35,000 payment by the employer was pursuant to a policy of charity to families of deceased employees, and there is authority for excluding this item as a gift. The IRS will probably challenge the exclusion of the $35,000. The IRS would argue that a policy of making the payment to all families of deceased employees makes the payment appear to be in the nature of compensation for prior services. Life insurance proceeds are tax-exempt. However, all interest paid on life insurance proceeds is includible in gross income

101. Barbara was injured in an automobile accident. She has threatened to file a suit against the other party involved in the accident and has proposed the following settlement:

Damages for 25% loss of the use of her right arm	$200,000
Medical expenses	30,000
Loss of wages	10,000
Punitive damages	100,000
	$340,000

Barbara’s claim for punitive damages of $100,000 is the only taxable amount. Therefore, her after-tax proceeds from receiving the $340,000 would be $305,000 [$340,000 – .35($100,000)]. None of the offer from the insurance company ($340,000) would be taxable and therefore her after-tax proceeds from the settlement would be $340,000. Thus, both the insurance company and Barbara would benefit from her accepting the insurance company’s offer.

George will probably be required to recognize $120 income from the service contract. The company can sell the service contract to an employee at a 20% discount and the employee is not required to recognize income. George received a 100% discount; therefore, $120 (80% ´ $150) must be included in his gross income. However, George can perhaps make a convincing argument that he is merely receiving a no-additional-cost service, and thus would not be required to recognize income. George will not be required to recognize income from the bargain purchase of the refrigerator because he paid more than the employer’s cost.

If Sonja returns to the United States, she will not be present in the foreign country for the requisite period (at least 330 days during any 12 consecutive months). Thus, she will not be eligible for the foreign earned income exclusion. Her income will be subject to the 25% rate in the United States. Although she will be given credit for the taxes paid in Spain, the net effect of not extending the stay is to increase her tax rate from 11% to 25% on her income for the 15-month period (the original 10 months plus the additional 5 months under consideration). This would cost her $16,800 [(.25 – .11) ´ (15 ´ $8,000)]. The higher pay in the United States would yield only additional after-tax income of $9,000 [($10,000 – $8,000)(1 – .25)(6 months)]. Since the benefits of the foreign income exclusion are greater than the loss of income, it would be beneficial to stay in Spain, from an after-tax income point of view.

Juan will receive $5,000 before-tax from the bond fund. The state income tax is $500 [(.10)($5,000)]. The state income tax will be deductible on the Federal return; thus, the state taxes will reduce Juan’s after-tax income by only $325 [(1 – .35)($500]. Therefore, the annual after-tax return is $4,675 ($5,000 – $325), or 4.675%. The double-exempt bonds will yield 4.9% after tax; therefore, it is the preferred investment, assuming equal risks.

Margaret can accumulate $11,948 by investing her funds for 4 years, but then she must pay the actual tuition. Alternatively, if she invests the $10,000 in a qualified tuition program, the tuition will be paid in 4 years, regardless of the amount. The amount of the tuition less the $10,000 will not be subject to tax. Thus, the after-tax future value of the qualified tuition fund is $12,155 ($12,155 – $0), which is greater than the alternative accumulated value. Therefore, it appears that Margaret should participate.

Gull is not required to recognize income from the shareholders exchanging the debt for stock (a nontaxable contribution to capital). The $80,000 reduction in debt ($150,000 – $70,000) to trade creditors can be used to reduce the basis in the goods purchased. However, Gull is required to recognize $30,000 gain ($120,000 – $90,000) from transferring the equipment in satisfaction of the debt. However, because Gull is in bankruptcy, the $150,000 income from discharge of indebtedness on the mortgage held by Old Line, can be used to reduce tax attributes (e.g., net operating loss carryover, basis in assets).

The argument that Carmen and her spouse realize income from the payments is as follows: the employer was compensating for the employee’s prior services. The fact that the employer had no legal obligation to make the payments is not relevant since the employer realized a benefit (prevention of embarrassment).

The argument that Carmen and her spouse do not realize income is predicated upon characterizing the payments as a gift. Conditions which indicate that a gift was intended include the following: the spouse’s dire financial condition; the decedent had been fully compensated for her past services, and any benefits the corporation received from the payments were indirect because there was no obligation to pay such amounts.

The $12,000 hospital payment is taxable because the gift is likely taxable income to her estate, as income in respect of the decedent, because the gift exclusion does not apply to payments by the employer to the employee.

108. What are the tax problems associated with payments received by a wife from her deceased husband’s employer? (Assume the wife renders no services to the employer.)

An amount paid in respect of compensation owed to the employee at the time of his death is taxable to the spouse, just as the amount would have been taxable to the decedent if he had received the money prior to death. Additional noninvested amounts paid by the employer probably should be totally excluded from the spouse’s income as a gift. However, the IRS generally considers such payments to be compensation for past services rather than gifts.

Payments received from the employer’s qualified pension or profit sharing plan are subject to taxation. Also, if the employee contributed to the pension and profit sharing plan, the beneficiary is allowed to treat this amount as a nontaxable recovery of capital.

Was Bob’s behavior consistent with the Congressional intent in providing the tax exemption he was permitted to use?

No. Bob was permitted to exclude from his gross income the $70,000 gain ($120,000 – $50,000) he realized from cashing in the policy. The exclusion was permitted because he was terminally ill. The rationale for the exclusion is that often the person with the terminal illness will have the need for funds to be used for his or her medical care. Bob is clearly not using the funds for this purpose to be served by the law. Nevertheless, the law does not prevent Bob from obtaining the exclusion.

Only the collections on the employer-sponsored income protection policy are subject to tax. The hospitalization benefits received from the employer sponsored plan are specifically excluded. Both the premiums and the payments can be excluded. The amounts Ben collected on a policy he purchased are specifically excluded under the rationale that the payments are a recovery of Ben’s premiums.

Cafeteria plans are beneficial where employees desire different types of benefits. This often occurs when employees are married and their spouses receive some benefits from their employers. For example, if the husband is covered by health insurance provided by his employer, there is no need for the wife’s employer to provide coverage for the husband also. Moreover, some employees may need child care benefits while those without children may prefer cash. The cafeteria plan provides much greater flexibility in planning benefits.

112. What Federal income tax benefits are provided for college students?

The Federal income tax system provides direct benefits to college students and indirect benefits by providing tax relief for the parents of the students. College students can receive tax-exempt scholarships. The interest on educational savings bonds, which are often purchased by parents may be exempt where the proceeds are used to pay qualified educational expenses. The qualified tuition program enables parents to fund the educational expenses of their children without any income being taxed to the parents or to children.

The taxpayer realized a benefit because the deduction in 2013 yielded benefits of $.35 for each dollar of deductions, while the recovery of the prior deduction was taxed at only 15%. The taxpayer’s benefit was $1,000 [(.35 – .15)($5,000)].

114. Employers can provide numerous benefits to their employees and the employees are permitted to exclude the value of these benefits from gross income. What are the effects of the exclusions on:

a.	The progressiveness of the tax system?
b.	The complexity of the tax system?

a.	The benefit of an exclusion varies directly with the recipient’s marginal tax rate. Thus, individuals with the highest marginal tax rate enjoy the greatest benefit from the exclusion and those taxpayers in the lowest marginal tax rate enjoy the least benefit. Also, generally, the exclusions are often available with the better paying jobs. This also causes the tax system to be less progressive than if the exclusions were not permitted.

b.	Any exclusion creates complexities in the system because tests must be established to determine whether the benefit is eligible (e.g., whether the benefit is provided on in a discriminatory manner) for the special treatment. Also, often limitations are often created, which requires even more testing.

a.	Explain whether each of these individuals has realized income from the reduction in the debt.
b.	Assume that under the current system of measuring income, each of these taxpayers realized income from the reductions in the mortgages. Should either of these taxpayers be permitted to exclude any of the debt reduction income?

a.	Each taxpayer’s liabilities were reduced. Therefore, their net worth has increased as measured using the cost basis in the assets. Each taxpayer also experienced a loss in the value of their assets. However, the losses were not realized (because each taxpayer still owns the property). Thus, each taxpayer had income from the reduction in debt, but no recognized loss. Fortunately, recent legislation permits the taxpayer whose property is a personal residence to exclude the amount of the debt reduction from gross income. The taxpayer who owns the rental home is not eligible for the debt reduction exclusion.

b.	Allowing the exclusion from income for the homeowner but not for the investor can only be justified on the basis of a value system that says we should bend the otherwise equitable rules to favor home ownership.

The state and local governments benefit from the exemption because they are required to pay less interest. The exemption costs the Federal government, and thus the exemption shifts resources from the Federal to the state and local governments. The investors do not derive any benefit from the exemption, in this example, because the market drives the price of the exempt bonds upward so that the after-tax yields on the bonds are equal for investors in the highest marginal tax bracket (35%).

South Western Federal Taxation 2014 Comprehensive 37th Edition By William H. Hoffman – Test Bank

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