Chapter 5 Gross Income: Exclusions

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Discussion Questions
1. LO.2 Fred specified in his will that his nephew John should serve as executor of
Fred’s estate. John received $10,000 for serving as executor. Can John exclude the $10,000 from his gross income? Explain.
2. LO.2 Leonard’s home was damaged by a fire. He also had to be absent from work for several days to make his home habitable. Leonard’s employer paid Leonard his regular salary, $2,500, while he was absent from work. In Leonard’s pay envelope was the following note from the employer: To help you in your time of need. Leonard’s fellow employees also took up a collection and gave him $900.
Leonard spent over $4,000 repairing the fire damage.
Based on the above information, how much is Leonard required to include in his gross income?
3. LO.2 Dolly is a college student who works as a part-time server in a restaurant. Her usual tip is 20% of the price of the meal. A customer ordered a piece of pie and said that he would appreciate prompt service. Dolly abided with the customer’s request. The customer’s bill was $8, but the customer left a $100 bill on the table and did not ask for a receipt. Dolly gave the cashier $8 and pocketed the $100 bill.
Dolly concludes that the customer thought that he had left a $10 bill, although the customer did not return to correct the apparent mistake. The customer had commented about how much he appreciated Dolly’s prompt service. Dolly thinks that a $2 tip would be sufficient and that the other $98 is like “found money.” How much should Dolly include in her gross income?
4. LO.2 Carey is a waiter at a restaurant that pays a small hourly amount plus tips.
Customers are not required to tip the waiter. Carey is especially attentive and friendly, and her tips average 25% of the restaurant charges. Is Carey required to include any of her tips in gross income when the customer has no legal obligation to make the payment? Explain the basis for your conclusion.
5. LO.2 Lime Finance Company requires its customers to purchase a credit life insurance policy associated with the loans it makes. Lime is the beneficiary of the policy to the extent of the remaining balance on the loan at the time of the customer’s death. In 2015, Lime wrote off as uncollectible a $5,000 account receivable from
Wally, which included $1,500 of accrued interest. When Wally died in 2016, the life insurance policy was still in force and Lime received $3,500. Is the $3,500 of life insurance proceeds received by Lime included in its gross income? Explain.
6. LO.2 Billy fell off a bar stool and hurt his back. As a result, he was unable to work for three months. He sued the bar owner and collected $100,000 for the physical injury and $50,000 for the loss of income. Billy also collected $15,000 from an income replacement insurance policy he purchased. Amber was away from work for three months following heart bypass surgery. Amber collected $30,000 under an income replacement insurance policy purchased by her employer. Are the amounts received by Billy and Amber treated the same under the tax law? Explain.
7. LO.2 Wes was a major league baseball pitcher who earned $10 million for his 20 wins this year. Sam was also a major league baseball pitcher before a careerending injury caused by a negligent driver. Sam sued the driver and collected $6 million as compensation for lost estimated future income as a pitcher and $4 million as punitive damages. Do the amounts that Wes and Sam receive have the same effect on their gross income? Explain.
8. LO.2 Holly was injured while working in a factory and received $12,000 as workers’ compensation while she was unable to work because of the injury. Jill, who was self-employed, was also injured and unable to work. Jill collected $12,000 on an insurance policy she had purchased to replace her loss of income while she was unable to work. How much are Holly and Jill each required to include in their gross income?
9. LO.2, 5 Casey is in the 15% marginal tax bracket, and Jean is in the 35% marginal tax bracket. Their employer is experiencing financial difficulties and cannot continue to pay for the company’s health insurance plan. The annual premiums are approximately $8,000 per employee. The employer has proposed to either (1) require the employee to pay the premiums or (2) reduce each employee’s pay by $10,000 per year with the employer paying the premium. Which option is less objectionable to Casey, and which is less objectionable to Jean?
10. LO.2 What is the difference between a cafeteria plan and an employee flexible spending plan?
11. LO.2 Ted works for Azure Motors, an automobile dealership. All employees can buy a car at the company’s cost plus 2%. The company does not charge employees the $300 dealer preparation fee that nonemployees must pay. Ted purchased an automobile for $29,580 ($29,000t$580). The company’s cost was $29,000. The price for a nonemployee would have been $33,900 ($33,600t$300 preparation fee). What is Ted’s gross income from the purchase of the automobile?
12. LO.2, 5 Wilbur has been offered a job at a salary that would put him in the 25% marginal tax bracket. In addition to his salary, he would receive health insurance coverage. Another potential employer does not offer health insurance but has agreed to match the first offer on an after-tax and insurance basis. The cost of health insurance comparable to that provided by the other potential employer is $9,000 per year. How much more in salary must the second potential employer pay so that Wilbur’s financial status will be the same under both offers?
13. LO.2, 5 Eagle Life Insurance Company pays its employees $.30 per mile for driving their personal automobiles to and from work. The company reimburses each employee who rides the bus $100 a month for the cost of a pass. Tom collected $100 for his automobile mileage, and Mason received $100 as reimbursement for the cost of a bus pass.
a. What are the effects of the above on Tom’s and Mason’s gross income?
b. Assume that Tom and Mason are in the 28% marginal tax bracket and the actual before-tax cost for Tom to drive to and from work is $.30 per mile. What are
Tom’s and Mason’s after-tax costs of commuting to and from work?
14. LO.2 Several of Egret Company’s employees have asked the company to create a hiking trail that employees could use during their lunch hours. The company owns vacant land that is being held for future expansion but would have to spend approximately $50,000 if it were to make a trail. Nonemployees would be allowed to use the facility as part of the company’s effort to build strong community support.
What are the relevant tax issues for the employees?
15. LO.2 The Sage Company has the opportunity to purchase a building located next to its office. Sage would use the building as a day care center for the children of its employees and an exercise facility for the employees. Occasionally, portions of the building could be used for employees’ family events such as reunions, birthday parties, and anniversaries. The company would like to know if the planned uses of the building would fit into a beneficially taxed employee compensation plan.
16. LO.2, 5 Tammy, a resident of Virginia, is considering purchasing a North Carolina bond that yields 4.6% before tax. She is in the 35% Federal marginal tax bracket and the 5% state marginal tax bracket. She is aware that State of Virginia bonds of comparable risk are yielding 4.5%. However, the Virginia bonds are exempt from Virginia tax, but the North Carolina bond interest is taxable in Virginia.
Which of the two options will provide the greater after-tax return to Tammy? Tammy can deduct any state taxes paid on her Federal income tax return.
17. LO.2 Andrea entered into a § 529 qualified tuition program for the benefit of her daughter, Joanna. Andrea contributed $15,000 to the fund. The fund balance had accumulated to $25,000 by the time Joanna was ready to enter college. However,
Joanna received a scholarship that paid for her tuition, fees, books, supplies, and room and board. Therefore, Andrea withdrew the funds from the § 529 plan and bought Joanna a new car.
a. What are the tax consequences to Andrea of withdrawing the funds?
b. Assume instead that Joanna’s scholarship did not cover her room and board, which cost $7,500 per academic year. During the current year, $7,500 of the fund balance was used to pay for Joanna’s room and board. The remaining amount was left in the § 529 plan to cover her room and board for future academic years. What are the tax consequences to Andrea and to Joanna of using the $7,500 to pay for the room and board?
18. LO.3 Dolly is a cash basis taxpayer. In 2016, she filed her 2015 South Carolina income tax return and received a $2,200 refund. Dolly took the standard deduction on her 2015 Federal income tax return, but will itemize her deductions in
2016. Molly, a cash basis taxpayer, also filed her 2015 South Carolina income tax return in 2016 and received a $600 refund. Molly had $12,000 in itemized deductions on her 2015 Federal income tax return, but will take the standard deduction in
2016. How does the tax benefit rule apply to Dolly’s and Molly’s situations? Explain.
19. LO.4 Ralph has experienced financial difficulties as a result of his struggling business.
He has been behind on his mortgage payments for the last six months.
The mortgage holder, who is a friend of Ralph’s, has offered to accept $80,000 in full payment of the $100,000 owed on the mortgage and payable over the next 10 years.
The interest rate of the mortgage is 7%, and the market rate is now 8%. What tax issues are raised by the creditor’s offer?