Chapter 4 Gross Income: Concepts And Inclusions

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46. LO.4 Alicia and Rafel are in the process of negotiating a divorce agreement. They both worked during the marriage and contributed an equal amount to the marital assets. They own a home with a fair market value of $400,000 (cost of $300,000) that is subject to a mortgage of $250,000. They have lived in the home for 12 years. They also have investment assets with a cost of $160,000 and a fair market value of $410,000. Thus, the net worth of the couple is $560,000 ($400,000 _ $250,000 t $410,000). The holding period for the investments is longer than one year. Alicia would like to continue to live in the house. Therefore, she has proposed that she receive the residence subject to the mortgage, a net value of $150,000. In addition, she would receive $17,600 each year for the next 10 years, which has a present value (at 6% interest) of $130,000. Rafel would receive the investment assets. If Rafel accepts this plan, he must sell one-half of the investments so that he can purchase a home. Assume that you are counseling Alicia. Explain to
Alicia whether the proposed agreement would be “fair” on an after-tax basis.
47. LO.4, 5 Roy decides to buy a personal residence and goes to the bank for a $150,000 loan. The bank tells him that he can borrow the funds at 4% if his father will guarantee the debt. Roy’s father, Hal, owns a $150,000 CD currently yielding 3.5%. The
Federal rate is 3%. Hal agrees to either of the following:
• Roy borrows from the bank with Hal’s guarantee to the bank.
• Cash in the CD (with no penalty), and lend Roy the funds at 2% interest.
Hal is in the 33% marginal tax bracket. Roy, whose only source of income is his salary, is in the 15% marginal tax bracket. The interest Roy pays on the mortgage will be deductible by him. Which option will maximize the family’s after-tax wealth?
48. LO.2, 4 Ridge is a generous individual. During the year, he made interest-free loans to various family members when the Federal rate was 3%. What are the tax consequences of the following loans by Ridge:
a. On June 30, 2015, Ridge loaned $12,000 to his cousin, Jim, to buy a used truck.
Jim’s only source of income was his wages on various construction jobs during the year.
b. On August 1, 2015, Ridge loaned $8,000 to his niece, Sonja. The loan was to enable her to pay her college tuition. Sonja had $1,200 interest income from
CDs her parents had given her.
c. On September 1, 2015, Ridge loaned $25,000 to his brother, Al, to start a business.
Al had $220 of dividends and interest for the year.
d. On September 30, 2015, Ridge loaned $150,000 to his mother so that she could enter a nursing home. His mother’s only income was $9,000 of Social Security benefits and $500 of interest income.
49. LO.4 Indicate whether the imputed interest rules should apply in the following situations.
Assume that all of the loans were made at the beginning of the tax year unless otherwise indicated.
a. Mike loaned his sister $90,000 to buy a new home. Mike did not charge interest on the loan. The Federal rate was 5%. Mike’s sister had $900 of investment income for the year.
b. Sam’s employer maintains an emergency loan fund for its employees. During the year, Sam’s wife was very ill, and he incurred unusually large medical expenses. He borrowed $8,500 from his employer’s emergency loan fund for six months. The Federal rate was 5.5%. Sam and his wife had no investment income for the year.
c. Jody borrowed $25,000 from her controlled corporation for six months. She used the funds to pay her daughter’s college tuition. The corporation charged
Jody 4% interest. The Federal rate was 5%. Jody had $3,500 of investment income for the year.
d. Kait loaned her son, Jake, $60,000 for six months. Jake used the $60,000 to pay off college loans. The Federal rate was 5%, and Kait did not charge Jake any interest.
Jake had dividend and interest income of $2,100 for the tax year.
50. LO.4 Vito is the sole shareholder of Vito, Inc. He is also employed by the corporation.
On June 30, 2016, Vito borrowed $8,000 from Vito, Inc., and on July 1, 2017, he borrowed an additional $10,000. Both loans were due on demand. No interest was charged on the loans, and the Federal rate was 4% for all relevant dates. Vito used the money to purchase a boat, and he had $2,500 of investment income. Determine the tax consequences to Vito and Vito, Inc., in each of the following situations:
a. The loans are considered employer-employee loans.
b. The loans are considered corporation-shareholder loans.
51. LO.4 Pam retires after 28 years of service with her employer. She is 66 years old and has contributed $42,000 to her employer’s qualified pension fund. She elects to receive her retirement benefits as an annuity of $3,000 per month for the remainder of her life.
a. Assume that Pam retires in June 2016 and collects six annuity payments this year. What is her gross income from the annuity payments in the first year?
b. Assume that Pam lives 25 years after retiring. What is her gross income from the annuity payments in the twenty-fourth year?
c. Assume that Pam dies after collecting 160 payments. She collected eight payments in the year of her death. What are Pam’s gross income and deductions from the annuity contract in the year of her death?
52. LO.4 For each of the following, determine the amount that should be included in gross income:
a. Peyton was selected the most valuable player in the Super Bowl. In recognition of this, he was awarded an automobile with a value of $60,000. Peyton did not need the automobile, so he asked that the title be put in his parents’ names.
b. Jacob was awarded the Nobel Peace Prize. When he was presented the check for $1.4 million, Jacob said, “I do not need the money. Give it to the United
Nations to use toward the goal of world peace.”
c. Linda won the Craig County Fair beauty pageant. She received a $10,000 scholarship that paid her $6,000 for tuition and $4,000 for meals and housing for the academic year.
53. LO.4 The LMN Partnership has a group term life insurance plan. Each partner has $150,000 of protection, and each employee has protection equal to twice his or her annual salary. Employee Alice (age 32) has $90,000 of insurance under the plan, and partner Kay (age 47) has $150,000 of coverage. Because the plan is a “group plan,” it is impossible to determine the cost of coverage for an individual employee or partner.
a. Assuming that the plan is nondiscriminatory, how much must Alice and Kay each include in gross income as a result of the partnership paying the insurance premiums?
b. Assume that the partnership is incorporated. Kay becomes a shareholder and an employee who receives a $75,000 annual salary. The corporation provides Kay with $150,000 of group term life insurance coverage under a nondiscriminatory plan. What is Kay’s gross income as a result of the corporation paying the insurance premiums?
54. LO.2, 4 Herbert was employed for the first six months of 2016 and earned $90,000 in salary. During the next six months, he collected $8,800 of unemployment compensation, borrowed $12,000 (using his personal residence as collateral), and withdrew $2,000 from his savings account (including $60 of interest). He received dividends of $550. His luck was not all bad, for in December, he won $1,500 in the lottery on a $5 ticket. Calculate Herbert’s gross income.
55. LO.4, 5 Linda and Don are married and file a joint return. In 2016, they received $12,000 in Social Security benefits and $35,000 in taxable pension benefits and interest.
a. Compute the couple’s adjusted gross income on a joint return.
b. Don would like to know whether they should sell for $100,000 (at no gain or loss) a corporate bond that pays 8% in interest each year and use the proceeds to buy a $100,000 nontaxable State of Virginia bond that will pay $6,000 in interest each year.
c. If Linda in part (a) works part-time and earns $30,000, how much will Linda and Don’s adjusted gross income increase?
56. LO.4 Melissa, who is 70 years old, is unmarried and has no dependents. Her annual income consists of a taxable pension of $17,000, $14,000 in Social Security benefits, and $3,000 of dividend income. She does not itemize her deductions. She is in the 15% marginal income tax bracket. She is considering getting a part-time job that would pay her $5,000 a year.
a. What would be Melissa’s after-tax income fromthe part-time job, considering Social
Security and Medicare tax (7.65%) as well as Federal income tax on the earnings of $5,000?
b. What would be the effective tax rate (increase in tax/increase in income) on the additional income from the part-time job?
57. LO.3, 4 Donna does not think she has an income tax problem but would like to discuss her situation with you just to make sure there is no unexpected tax liability. Base your suggestions on the following relevant financial information:
a. Donna’s share of the SAT Partnership income is $150,000, but none of the income can be distributed because the partnership needs the cash for operations.
b. Donna’s Social Security benefits totaled $8,400, but Donna loaned the cash received to her nephew.
c. Donna assigned to a creditor the right to collect $1,200 of interest on some bonds she owned.
d. Donna and her husband lived together in California until September, when they separated. Donna has heard rumors that her husband had substantial gambling winnings since they separated.
Cumulative Problems
58. Daniel B. Butler and Freida C. Butler, husband and wife, file a joint return. The
Butlers live at 625 Oak Street in Corbin, KY 40701. Dan’s Social Security number is
111-11-1112, and Freida’s is 123-45-6789. Dan was born on January 15, 1965, and
Freida was born on August 20, 1966.
During 2015, Dan and Freida furnished over half of the total support of each of the following individuals, all of whom still live at home:
a. Gina, their daughter, age 22, a full-time student, who married on December 21, 2015, has no income of her own and for 2015 did not file a joint return with her husband, Casey, who earned $10,600 during 2015. Gina’s Social Security number is 123-45-6788.
b. Sam, their son, age 20, who had gross income of $6,300 in 2015, dropped out of college in October 2015. He had graduated from high school in May 2015. Sam’s
Social Security number is 123-45-6787.
c. Ben, their oldest son, age 26, is a full-time graduate student with gross income of $5,200. Ben’s Social Security number is 123-45-6786.
Dan was employed as a manager by WJJJ, Inc. (employer identification number
11-1111111, 604 Franklin Street, Corbin, KY 40702), and Freida was employed as a salesperson for Corbin Realty, Inc. (employer identification number 98-7654321,
899 Central Street, Corbin, Ky 40701). Selected information from the W–2 Forms provided by the employers is presented below. Dan and Freida use the cash method.
Line Description Dan Freida
1 Wages, tips, other compensation $74,000 $86,000
2 Federal income tax withheld 11,000 12,400
17 State income tax withheld 2,960 3,440
Freida sold a house on December 30, 2015, and will be paid a commission of $3,100 (not included in the $86,000 reported on the W–2) on the January 10, 2016 closing date.
Other income (as reported on 1099 Forms) for 2015 consisted of the following:
Dividends on CSX stock (qualified) $4,200
Interest on savings at Second Bank 1,600
Interest on City of Corbin bonds 900
Interest on First Bank CD 382
The $382 from First Bank was original issue discount. Dan and Freida collected $16,000 on the First Bank CD that matured on September 30, 2015. The CD was purchased on October 1, 2013, for $14,995, and the yield to maturity was 3.3%.
Dan received a Schedule K–1 from the Falcon Partnership, which showed his distributive share of income as $7,000. In addition to the above information, Dan and
Freida’s itemized deductions included the following:
Paid on 2015 Kentucky income tax $ 700
Personal property tax paid 600
Real estate taxes paid 1,800
Interest on home mortgage (Corbin S&L) 4,900
Cash contributions to the Boy Scouts 800
Sales tax from the sales tax table is $1,860. Dan and Freida made Federal estimated tax payments of $8,000. All members of the family had health insurance coverage for all of 2015. Dan and Freida do not wish to contribute to the Presidential Election
Campaign. The Kentucky income tax rate is 4%.
Tax Return Problem
Part 1—Tax Computation
Compute Dan and Freida’s 2015 Federal income tax payable (or refund due). If you use tax forms for your computations, you will need Form 1040 and Schedules A, B, and E. Suggested software: H&R BLOCK Tax Software.
Part 2—Tax Planning
Dan plans to reduce his work schedule and work only half-time for WJJJ in 2016.
He has been writing songs for several years and wants to devote more time to developing a career as a songwriter. Because of the uncertainty in the music business, however, he would like you to make all computations assuming that he will have no income from songwriting in 2016. To make up for the loss of income, Freida plans to increase the amount of time she spends selling real estate. She estimates that she will be able to earn $90,000 in 2016. Assume that all other income and expense items will be approximately the same as they were in 2015. Assume that
Sam will be enrolled in college as a full-time student for the summer and fall semesters.
Will the Butlers have more or less disposable income (after Federal income tax) in 2016? Write a letter to the Butlers that contains your advice, and prepare a memo for the tax files.
59. Cecil C. Seymour is a 64-year-old widower. He had income for 2016 as follows:
Pension from former employer $39,850
Interest income from Alto National Bank 5,500
Interest income on City of Alto bonds 4,500
Dividends received from IBM stock held for over one year 2,000
Collections on annuity contract he purchased from Great Life Insurance 5,400
Social Security benefits 14,000
Rent income on townhouse 9,000
The cost of the annuity was $46,800, and Cecil was expected to receive a total of
260 monthly payments of $450. Cecil has received 22 payments through 2016.
Cecil’s 40-year-old daughter, Sarah C. Seymour, borrowed $60,000 from Cecil on
January 2, 2016. She used the money to start a new business. Cecil does not charge her interest because she could not afford to pay it, but he does expect to collect the principal eventually. Sarah is living with Cecil until the business becomes profitable.
Except for housing, Sarah provides her own support from her business and $1,600 in dividends on stocks that she inherited from her mother.
Other relevant information is presented below:
• Cecil’s Social Security number: 123-45-6785
• Address: 3840 Springfield Blvd., Alto, GA 30510
• Sarah’s Social Security number: 123-45-6784
• Expenses on rental townhouse:
Utilities $2,800
Maintenance 1,000
Depreciation 2,000
Real estate taxes 750
Insurance 700
• State income taxes paid: $3,500
• County personal property taxes paid: $2,100
• Payments on estimated 2015 Federal income tax: $5,900
• Charitable contributions of cash to Alto Baptist Church: $6,400
• Federal interest rate: 6%
• Sales taxes paid: $912
Compute Cecil’s 2016 Federal income tax payable (or refund due).
Tax Computation Problem