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Chapter 5 Gross Income: Exclusions
46. LO.2, 5 Rosa’s employer has instituted a flexible benefits program. Rosa will use the plan to pay for her daughter’s dental expenses and other medical expenses that are not covered by health insurance. Rosa is in the 28% marginal tax bracket and estimates that the medical and dental expenses not covered by health insurance will be within the range of $4,000 to $5,000. Her employer’s plan permits her to set aside as much as $5,000 in the flexible benefits account. Rosa does not itemize her deductions.
a. Rosa puts $4,000 into her flexible benefits account, and her actual expenses are $5,000. What is her cost of underestimating the expenses?
b. Rosa puts $5,000 into her flexible benefits account, and her actual expenses are only $4,000. What is her cost of overestimating her expenses?
c. What is Rosa’s cost of underfunding as compared with the cost of overfunding the flexible benefits account?
d. Does your answer in part (c) suggest that Rosa should fund the account closer to the low end or to the high end of her estimates?
47. LO.2 Sparrow Corporation would like you to review its employee fringe benefits program with regard to the tax consequences of the plan for the company’s president (Polly), who is also the majority shareholder.
a. The company has a qualified retirement plan. The company pays the cost of employees attending a retirement planning seminar. The employee must be within 10 years of retirement, and the cost of the seminar is $1,500 per attendee.
b. The company owns a parking garage that is used by customers, employees, and the general public. Only the general public is required to pay for parking.
The charge to the general public for Polly’s parking for the year would have been $3,600 (a $300 monthly rate).
c. All employees are allowed to use the company’s fixed charge long-distance telephone services, as long as the privilege is not abused. Although no one has kept track of the actual calls, Polly’s use of the telephone had a value (what she would have paid on her personal telephone) of approximately $600.
d. The company owns a condominium at the beach, which it uses to entertain customers.
Employees are allowed to use the facility without charge when the company has no scheduled events. Polly used the facility 10 days during the year. Her use had a rental value of $1,000.
e. The company is in the household moving business. Employees are allowed to ship goods without charge whenever there is excess space on a truck. Polly purchased a dining room suite for her daughter. Company trucks delivered the furniture to the daughter. Normal freight charges would have been $750.
f. The company has a storage facility for household goods. Officers are allowed a
20% discount on charges for storing their goods. All other employees are allowed a 10% discount. Polly’s discounts for the year totaled $900.
48. LO.2 George is a U.S. citizen who is employed by Hawk Enterprises, a global company.
Beginning on June 1, 2016, George began working in London. He worked there until January 31, 2017, when he transferred to Paris. He worked in
Paris the remainder of 2017. His salary for the first five months of 2016 was $100,000, and it was earned in the United States. His salary for the remainder of
2016 was $175,000, and it was earned in London. George’s 2017 salary from Hawk was $300,000, with part being earned in London and part being earned in Paris.
What is George’s gross income in 2016 and 2017? (Assume that the 2017 indexed amount is the same as the 2016 indexed amount.)
49. LO.2, 3 Determine Hazel’s gross income from the following receipts for the year:
Gain on sale of Augusta County bonds $800
Interest on U.S. government savings bonds 400
Interest on state income tax refund 200
Interest on Augusta County bonds 700
Patronage dividend from Potato Growers Cooperative 350
The patronage dividend was received in March of the current year for amounts paid for her (nondeductible) garden and lawn supplies.
50. LO.2 In January 2016, Ezra purchased 2,000 shares of Gold Utility Mutual Fund for $20,000. In June, Ezra received an additional 100 shares as a dividend, in lieu of receiving $1,000 in cash dividends. In December, the company declared a two-for-one stock split. Ezra received an additional 2,100 shares, but there was no option to receive cash. At the time of the stock dividend in December and at the end of the year, the fund shares were trading for $5 per share. Also, at the end of the year, the fund offered to buy outstanding shares for $4.50. Ezra did not sell any shares during the year.
a. What is Ezra’s gross income from the 100 shares received in June?
b. What is Ezra’s gross income from the receipt of the 2,100 shares as a two-forone stock split in December?
c. Should Ezra be required to recognize gross income in 2016 even though the fair market value of his investment at the end of the year was less than the fair market value at the beginning of the year? Explain.
51. LO.2 Tonya, who lives in California, inherited a $100,000 State of California bond in 2016. Her marginal Federal tax rate is 35%, and her marginal state tax rate is 5%. The California bond pays 3.3% interest, which is not subject to California income tax. She can purchase a corporate bond of comparable risk that will yield
5.2% or a U.S. government bond that pays 4.6% interest. Which investment will provide the greatest after-tax yield?
52. LO.2 Lynn Swartz’s husband died three years ago. Her parents have an income of over $200,000 a year and want to ensure that funds will be available for the education of Lynn’s 8-year-old son, Eric. Lynn is currently earning $45,000 a year.
Lynn’s parents have suggested that they start a savings account for Eric. They have calculated that if they invest $4,000 a year for the next 8 years, at the end of 10 years, sufficient funds will be available for Eric’s college expenses. Lynn realizes that the tax treatment of the investments could significantly affect the amount of funds available for Eric’s education. She asked you to write a letter to her advising about options available to her parents and to her for Eric’s college education. Lynn’s address is 100 Myrtle Cove, Fairfield, CT 06824.
53. LO.2 Starting in 2005, Chuck and Luane have been purchasing Series EE bonds in their name to use for the higher education of their daughter Susie, who currently is age 18. During the year, they cash in $12,000 of the bonds to use for freshman year tuition, fees, and room and board. Of this amount, $5,000 represents interest. Of the $12,000, $8,000 is used for tuition and fees, and $4,000 is used for room and board. Chuck and Luane’s AGI, before the educational savings bond exclusion, is $120,000. Review § 135, and answer the following questions.
a. Determine the tax consequences for Chuck and Luane, who will file a joint return, and for Susie.
b. Assume that Chuck and Luane purchased the bonds in Susie’s name. Determine the tax consequences for Chuck and Luane and for Susie.
c. Howwould your answer to part (a) change if Chuck and Luane filed separate returns?
54. LO.2 Albert established a qualified tuition program for each of his twins, Kim and
Jim. He started each fund with $20,000 when the children were 5 years old.
Albert made no further contributions to his children’s plans. Thirteen years later, both children have graduated from high school. Kim’s fund has accumulated to $45,000, while Jim’s has accumulated to $42,000. Kim decides to attend a state university, which will cost $60,000 for four years (tuition, fees, room and board, and books). Jim decides to go to work instead of going to college. During the current year, $7,500 is used from Kim’s plan to pay the cost of her first semester in college.
Because Jim is not going to college now or in the future, Albert withdraws the $42,000 plan balance and gives it to Jim to start his new life after high school.
a. During the period since the plans were established, should Albert or the twins have been including the annual plan earnings in gross income? Explain.
b. What are the tax consequences to Kim and Albert of the $7,500 being used for the first semester’s higher education costs?
c. Because of her participation in the qualified tuition program, Kim received a
10% reduction in tuition charges; so less than $7,500 was withdrawn from her account. Is either Albert or Kim required to include the value of this discount in gross income? Explain.
d. What are the tax consequences to Albert and Jim of Jim’s qualified tuition program being closed?
55. LO.3 How does the tax benefit rule apply in the following cases?
a. In 2014, the Orange Furniture Store, an accrual method taxpayer, sold furniture on credit for $1,000 to Sammy. The cost of the furniture was $600. In 2015,
Orange took a bad debt deduction for the $1,000. In 2016, Sammy inherited some money and paid Orange the $1,000 he owed. Orange was in the 35% marginal tax bracket in 2014, the 15% marginal tax bracket in 2015, and the 35% marginal tax bracket in 2016.
b. In 2015, Marvin, a cash basis taxpayer, took a $2,000 itemized deduction for state income taxes paid. This increased his itemized deductions to a total that was $800 more than the standard deduction. In 2015, Marvin received a $1,600 refund when he filed his 2015 state income tax return. Marvin was in the 15% marginal tax bracket in 2015, but was in the 35% marginal tax bracket in 2016.
c. In 2015, Barb, a cash basis taxpayer, was in an accident and incurred $8,000 in medical expenses, which she claimed as an itemized deduction for medical expenses. Because of the 10%-of-AGI reduction, the expense reduced her taxable income by only $3,000. In 2016, Barb successfully sued the person who caused the physical injury and collected $8,000 to reimburse her for the cost of her medical expenses. Barb was in the 15% marginal tax bracket in both 2015 and 2016.
56. LO.4, 5 Fran, who is in the 35% tax bracket, recently collected $100,000 on a life insurance policy she carried on her father. She currently owes $120,000 on her personal residence and $120,000 on business property. National Bank holds the mortgage on both pieces of property and has agreed to accept $100,000 in complete satisfaction of either mortgage. The interest rate on the mortgages is 8%, and both mortgages are payable over 10 years. What would be the tax consequences of each of the following alternatives assuming that Fran currently deducts the mortgage interest on her tax return?
a. Retire the mortgage on the residence.
b. Retire the mortgage on the business property.
Which alternative should Fran select?
57. LO.4 Vic, who was experiencing financial difficulties, was able to adjust his debts as follows:
a. Vic is an attorney. Vic owed his uncle $25,000. The uncle told Vic that if he serves as the executor of the uncle’s estate, Vic’s debt will be canceled in the uncle’s will.
b. Vic borrowed $80,000 from First Bank. The debt was secured by land that Vic purchased for $100,000. Vic was unable to pay, and the bank foreclosed when the liability was $80,000, which was also the fair market value of the property.
c. The Land Company, which had sold land to Vic for $80,000, reduced the mortgage on the land by $12,000.
Determine the tax consequences to Vic.
Cumulative Problems
58. Alfred E. Old and Beulah A. Crane, each age 42, married on September 7, 2013.
Alfred and Beulah will file a joint return for 2015. Alfred’s Social Security number is
111-11-1112. Beulah’s Social Security number is 123-45-6789, and she adopted “Old” as her married name. They live at 211 Brickstone Drive, Atlanta, GA 30304.
Alfred was divorced from Sarah Old in March 2013. Under the divorce agreement,
Alfred is to pay Sarah $1,250 per month for the next 10 years or until Sarah’s death, whichever occurs first. Alfred pays Sarah $15,000 in 2015. In addition, in
January 2015, Alfred pays Sarah $50,000, which is designated as being for her share of the marital property. Also, Alfred is responsible for all prior years’ income taxes.
Sarah’s Social Security number is 123-45-6788.
Alfred’s salary for 2015 is $150,000, and his employer, Cherry, Inc. (Federal I.D.
No. 98-7654321), provides him with group term life insurance equal to twice his annual salary. His employer withheld $24,900 for Federal income taxes and $8,000 for state income taxes. The proper amounts were withheld for FICA taxes.
Beulah recently graduated from law school and is employed by Legal Aid Society,
Inc. (Federal I.D. No. 11-1111111), as a public defender. She receives a salary of $40,000 in 2015. Her employer withheld $7,500 for Federal income taxes and $2,400 for state income taxes. The proper amounts were withheld for FICA taxes.
Beulah has $2,500 in qualified dividends on Yellow Corporation stock she inherited.
Alfred and Beulah receive a $1,900 refund on their 2014 state income taxes.
They itemized deductions on their 2014 Federal income tax return (total of $15,000).
Alfred and Beulah pay $4,500 interest and $1,450 property taxes on their personal residence in 2015. Their charitable contributions total $2,400 (all to their church).
They paid sales taxes of $1,400, for which they maintain the receipts. Both spouses had health insurance for all months of 2015 and do not want to contribute to the
Presidential Election Campaign.
Compute the Olds’ net tax payable (or refund due) for 2015. If you use tax forms for your solution, you will need Form 1040 and Schedules A and B. Suggested software:
H&R BLOCK Tax Software.
59. Martin S. Albert (Social Security number 111-11-1111) is 39 years old and is married to Michele R. Albert (Social Security number 123-45-6789). The Alberts live at 512
Ferry Road, Newport News, VA 23601. They file a joint return and have two dependent children, Charlene, age 17, and Jordan, age 18. Charlene’s Social Security number is 123-45-6788, and Jordan’s Social Security number is 123-45-6787. In 2016,
Martin and Michele had the following transactions:
a. Martin received $120,000 in salary from Red Steel Corporation, where he is a construction engineer. Withholding for Federal income tax was $10,750. The amounts withheld for FICA taxes were as follows: $7,049 ($113,700 _ 6:2%) for
Tax Return Problem
Tax Computation Problem
Social Security and $1,740 ($120,000 _ 1:45%) for Medicare. Martin worked in
Mexico from January 1, 2015, until February 15, 2016. His $120,000 salary for
2016 includes $18,000 he earned for January and one-half of February 2016 while working in Mexico.
b. Martin and Michele received $800 in qualified dividends on Green, Inc. stock and $400 interest on Montgomery County (Virginia) school bonds.
c. Martin received $2,300 interest from a Bahamian bank account.
d. Michele received 50 shares of Applegate Corporation common stock as a stock dividend. The shares had a fair market value of $2,500 at the time Michele received them, and she did not have the option of receiving cash.
e. Martin and Michele received a $1,200 refund on their 2015 Virginia income taxes.
Their itemized deductions in 2015 totaled $14,000.
f. Martin paid $6,600 alimony to his former wife, Rose T. Morgan (Social Security number 123-45-6786).
g. Martin and Michele kept the receipts for their sales taxes paid of $1,100.
h. Martin and Michele’s itemized deductions were as follows:
• State income tax paid and withheld totaled $5,100.
• Real estate taxes on their principal residence were $3,700.
• Mortgage interest on their principal residence was $2,500.
• Cash contributions to the church totaled $2,800.
Part 1—Tax Computation
Compute the Alberts’s net tax payable (or refund due) for 2016.
Part 2—Tax Planning
The Alberts are considering buying another house. Their house mortgage payments would increase by $500 (to $1,500) per month, which includes a $250 increase in interest and a $100 increase in property tax. The Alberts would like to know how much the mortgage payments would increase net of any change in their income tax.
Write a letter to the Alberts that contains your advice.