Chapter 5 Gross Income: Exclusions

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Problems
27. LO.2 Ed, an employee of the Natural Color Company, suffered from a rare disease that was very expensive to treat. The local media ran several stories about
Ed’s problems, and the family created a website that generated more than $10,000 in gifts from individuals to help pay the medical bills. Ed’s employer provided hospital and medical insurance for its employees, but the policy did not cover Ed’s illness.
When it became apparent that Ed could not pay all of his medical expenses, the hospital canceled the $25,000 Ed owed at the time of his death. After Ed’s death, his former employer paid Ed’s widow $12,000 in “her time of need.” Ed’s widow also collected $50,000 on a group term life insurance policy paid for by Ed’s employer.
What are Ed’s and his widow’s gross income?
28. LO.2 Determine the gross income of the beneficiaries in the following cases:
a. Justin’s employer was downsizing and offered employees an amount equal to one year’s salary if the employee would voluntarily retire.
b. Trina contracted a disease and was unable to work for six months. Because of her dire circumstances, her employer paid her one-half of her regular salary while she was away from work.
c. Coral Corporation collected $1 million on a key person life insurance policy when its chief executive died. The corporation had paid the premiums on the policy of $77,000, which were not deductible by the corporation.
d. Juan collected $40,000 on a life insurance policy when his wife, Leona, died in
2015. The insurance policy was provided by Leona’s employer, and the premiums were excluded from Leona’s gross income as group term life insurance. In
2016, Juan collected the $3,500 accrued salary owed to Leona at the time of her death.
29. LO.2, 5 Laura was recently diagnosed with cancer and has begun chemotherapy treatments. A cancer specialist has stated that Laura has less than one year to live. She has incurred many medical bills and other general living expenses and is in need of cash. Therefore, she is considering selling stock that cost $35,000 and has a fair market value of $50,000. This amount would be sufficient to pay her medical bills. However, she has read about a company (the Vital Benefits Company) that would purchase her life insurance policy for $50,000. She has paid $30,000 in premiums on the policy.
a. Considering only the tax effects, would selling the stock or selling the life insurance policy result in more beneficial tax treatment?
b. Assume that Laura is a dependent child and that her mother owns the stock and the life insurance policy, which is on the mother’s life. Which of the alternative means of raising the cash would result in more beneficial tax treatment?
30. LO.2 What is the taxpayer’s gross income in each of the following situations?
a. Darrin received a salary of $50,000 in 2016 from his employer, Green
Construction.
b. In July 2016, Green gave Darrin an all-expense-paid trip to Las Vegas (value of $3,000) for exceeding his sales quota.
c. Megan received $10,000 from her employer to help her pay medical expenses not covered by insurance.
d. Blake received $15,000 from his deceased wife’s employer “to help him in his time of greatest need.”
e. Clint collected $50,000 as the beneficiary of a group term life insurance policy when his wife died. The premiums on the policy were paid by his deceased wife’s employer.
31. LO.2 Donald was killed in an accident while he was on the job in 2016. Darlene,
Donald’s wife, received several payments as a result of Donald’s death. What is Darlene’s gross income from the items listed below?
a. Donald’s employer paid Darlene an amount equal to Donald’s three months’ salary ($60,000), which is what the employer does for all widows and widowers of deceased employees.
b. Donald had $20,000 in accrued salary that was paid to Darlene.
c. Donald’s employer had provided Donald with group term life insurance of $480,000 (twice his annual salary), which was payable to his widow in a lump sum. Premiums on this policy totaling $12,500 had been included in Donald’s gross income under § 79.
d. Donald had purchased a life insurance policy (premiums totaled $250,000) that paid $600,000 in the event of accidental death. The proceeds were payable to Darlene, who elected to receive installment payments as an annuity of $30,000 each year for a 25-year period. She received her first installment this year.
32. LO.2 Ray and Carin are partners in an accounting firm. The partners have entered into an arm’s length agreement requiring Ray to purchase Carin’s partnership interest from Carin’s estate if she dies before Ray. The price is set at 120% of the book value of Carin’s partnership interest at the time of her death. Ray purchased an insurance policy on Carin’s life to fund this agreement. After Ray had paid $45,000 in premiums, Carin was killed in an automobile accident and Ray collected $800,000 of life insurance proceeds. Ray used the life insurance proceeds to purchase Carin’s partnership interest.
a. What amount should Ray include in his gross income from receiving the life insurance proceeds?
b. The insurance company paid Ray $16,000 interest on the life insurance proceeds during the period Carin’s estate was in administration. During this period,
Ray had left the insurance proceeds with the insurance company. Is this interest taxable?
c. When Ray paid $800,000 for Carin’s partnership interest, priced as specified in the agreement, the fair market value of Carin’s interest was $1 million. How much should Ray include in his gross income from this bargain purchase?
33. LO.2 Sally was an all-state soccer player during her junior and senior years in high school. She accepted an athletic scholarship from State University. The scholarship provided the following:
Tuition and fees $15,000
Housing and meals 6,000
Books and supplies 1,500
Transportation 1,200
a. Determine the effect of the scholarship on Sally’s gross income.
b. Sally’s brother, Willy, was not a gifted athlete, but he received $8,000 from their father’s employer as a scholarship during the year. The employer grants the children of all executives a scholarship equal to one-half of annual tuition, fees, books, and supplies. Willy also received a $6,000 scholarship (to be used for tuition) as the winner of an essay contest related to bioengineering, his intended field of study. Determine the effect of the scholarships on Willy’s and his father’s gross income.
34. LO.2 Adrian was awarded an academic scholarship to State University for the
2016–2017 academic year. He received $6,500 in August and $7,200 in
December 2016. Adrian had enough personal savings to pay all expenses as they came due. Adrian’s expenditures for the relevant period were as follows:
Tuition, August 2016 $3,700
Tuition, January 2017 3,750
Room and board
August–December 2016 2,800
January–May 2017 2,500
Books and educational supplies
August–December 2016 1,000
January–May 2017 1,200
Determine the effect on Adrian’s gross income for 2016 and 2017.
35. LO.2 Leigh sued an overzealous bill collector and received the following settlement:
Damage to her automobile that the collector attempted to repossess $ 3,300
Physical damage to her arm caused by the collector 15,000
Loss of income while her arm was healing 6,000
Punitive damages 80,000
a. What effect does the settlement have on Leigh’s gross income?
b. Assume that Leigh also collected $25,000 of damages for slander to her personal reputation caused by the bill collector misrepresenting the facts to Leigh’s employer and other creditors. Is this $25,000 included in Leigh’s gross income? Explain.
36. LO.2 Determine the effect on gross income in each of the following cases:
a. Eloise received $150,000 in settlement of a sex discrimination case against her former employer.
b. Nell received $10,000 for damages to her personal reputation. She also received $40,000 in punitive damages.
c. Orange Corporation, an accrual basis taxpayer, received $50,000 from a lawsuit filed against its auditor who overcharged for services rendered in a previous year.
d. Beth received $10,000 in compensatory damages and $30,000 in punitive damages in a lawsuit she filed against a tanning parlor for severe burns she received from using its tanning equipment.
e. Joanne received compensatory damages of $75,000 and punitive damages of $300,000 from a cosmetic surgeon who botched her nose job.
37. LO.2 Rex, age 55, is an officer of Blue Company, which provides him with the following nondiscriminatory fringe benefits in 2016:
• Hospitalization insurance premiums for Rex and his dependents. The cost of the coverage for Rex is $2,900 per year, and the additional cost for his dependents is $3,800 per year. The plan has a $2,000 deductible, but his employer contributed $1,500 to Rex’s Health Savings Account (HSA). Rex withdrew only $800 from the
HSA, and the account earned $50 of interest during the year.
• Insurance premiums of $840 for salary continuation payments. Under the plan, Rex will receive his regular salary in the event he is unable to work due to illness. Rex collected $4,500 on the policy to replace lost wages while he was ill during the year.
• Rex is a part-time student working on his bachelor’s degree in engineering. His employer reimbursed his $5,200 tuition under a plan available to all full-time employees.
Determine the amount Rex must include in gross income.
38. LO.2 The UVW Union and HON Corporation are negotiating contract terms.
Assume that the union members are in the 25% marginal tax bracket and that all benefits are provided on a nondiscriminatory basis. Write a letter to the UVW
Union members explaining the tax consequences of the options discussed below.
The union’s address is 905 Spruce Street, Washington, DC 20227.
a. The company would eliminate the $250 deductible on medical insurance benefits.
Most employees incur more than $250 each year in medical expenses.
b. Employees would get an additional paid holiday with the same annual income (the same pay but less work).
c. An employee who did not need health insurance (because the employee’s spouse works and receives family coverage) would be allowed to receive the cash value of the coverage.
39. LO.2, 5 Mauve Corporation has a group hospitalization insurance plan that has a $200 deductible amount for hospital visits and a $15 deductible for doctor visits and prescriptions. The deductible portion paid by employees who have children has become substantial for some employees. The company is considering adopting a medical reimbursement plan or a flexible benefits plan to cover the deductible amounts. Either of these plans can be tailored to meet the needs of the employees. What are the cost considerations to the employer that should be considered in choosing between these plans?
40. LO.2 Belinda spent the last 60 days of 2016 in a nursing home. The cost of the services provided to her was $18,000 ($300 per day). Medicare paid $8,500 toward the cost of her stay. Belinda also received $5,500 of benefits under a long-term care insurance policy she purchased. What is the effect on Belinda’s gross income?
41. LO.2 Tim is the vice president of western operations for Maroon Oil Company and is stationed in San Francisco. He is required to live in an employer-owned home, which is three blocks from his company office. The company-provided home is equipped with high-speed Internet access and several telephone lines. Tim receives telephone calls and e-mails that require immediate attention any time of day or night because the company’s business is spread all over the world. A full-time administrative assistant resides in the house to assist Tim with the urgent business matters. Tim often uses the home for entertaining customers, suppliers, and employees.
The fair market value of comparable housing is $9,000 per month. Tim is also provided with free parking at his company’s office. The value of the parking is $350 per month. Calculate the amount associated with the company-provided housing and free parking that Tim must include in his gross income for 2016.
42. LO.2 Does the taxpayer recognize gross income in the following situations?
a. Ava is a filing clerk at a large insurance company. She is permitted to leave the premises for lunch, but she usually eats in the company’s cafeteria because it is quick and she is on a tight schedule. On average, she pays $2 for a lunch that would cost $12 at a restaurant. However, if the prices in the cafeteria were not so low and the food was not so delicious, she would probably bring her lunch at a cost of $3 per day.
b. Scott is an executive for an international corporation located in New York City.
Often he works late, taking telephone calls from the company’s European branch.
Scott often stays in a company-owned condominium when he has a late-night work session. The condominium is across the street from the company office.
c. Ira recently moved to take a job. For the first month on the new job, Ira was searching for a home to purchase or rent. During this time, his employer permitted
Ira to live in an apartment the company maintains for customers during the buying season. The month that Ira occupied the apartment was not during the buying season, and the apartment would not otherwise have been occupied.
43. LO.2, 5 Bertha is considering taking an early retirement offered by her employer.
She would receive $3,000 per month, indexed for inflation. However, she would no longer be able to use the company’s health facilities, and she would be required to pay her hospitalization insurance premiums of $8,000 each year. Bertha and her husband will file a joint return and take the standard deduction. She currently receives a salary of $55,000 a year. If she retires, she will spend approximately $300 less each month for commuting and clothing. Bertha and her husband have other sources of income and are in and will remain in the 25% marginal tax bracket. Her income tax for the current year was $8,875. She currently pays Social Security and
Medicare taxes of 7.65% on her salary, but her retirement pay would not be subject to this tax. According to Bertha, she and her husband could live well if her after-tax retirement income was at least 50% of her current income. Provide Bertha with information she will need to make her decision.
44. LO.2, 5 Finch Construction Company provides the carpenters it employs with all of the required tools. However, the company believes that this practice has led to some employees not taking care of the tools and to the mysterious disappearance of some tools. The company is considering requiring all of its employees to provide their own tools. Each employee’s salary would be increased by $1,500 to compensate for the additional cost. Write a letter to Finch’s management explaining the tax consequences of this plan to the carpenters. Finch’s address is 300 Harbor
Drive, Vermillion, SD 57069.
45. LO.2, 5 Bluebird, Inc., does not provide its employees with any tax-exempt fringe benefits. The company is considering adopting a hospital and medical benefits insurance plan that will cost approximately $9,000 per employee. To adopt this plan, the company may have to reduce salaries and/or lower future salary increases.
Bluebird is in the 35% (combined Federal and state rates) bracket. Bluebird is also responsible for matching the Social Security and Medicare taxes withheld on employees’ salaries (at the full 7.65% rate). The hospital and medical benefits insurance plan will not be subject to the Social Security and Medicare taxes, and the company is not eligible for the small business credit for health insurance. The employees generally fall into two marginal tax rate groups:
Income Tax
Social Security and
Medicare Tax Total .15 .0765 .2265 .35 .0145 .3645
The company has asked you to assist in its financial planning for the hospital and medical benefits insurance plan by computing the following:
a. How much taxable compensation is the equivalent of $9,000 of exempt compensation for each of the two classes of employees?
b. What is the company’s after-tax cost of the taxable compensation computed in part (a)?
c. What is the company’s after-tax cost of the exempt compensation?
d. Briefly explain your conclusions from the preceding analysis.