4. Business Income Flashcards
- Which of the following would not be considered income for tax purposes?
A. Interest earned on a court award.
B. Damages received in a suit or settlement for personal physical injuries.
C. Barter income from consulting services.
D. Legal damages awarded for copyright infringement.
The answer is B. Certain items of income are excluded from gross income by provisions in the Internal Revenue Code. Gross income does not include certain types of compensation for physical injuries.
- Evelyn is a self-employed bookkeeper who performs services for a client, a small corporation. In exchange for her services, the corporation gives Evelyn 500 shares of stock with a fair market value of $4,000. How would the transaction be reported?
A. Evelyn must report the stock as a capital gain.
B. This is not a taxable event. Evelyn would not have to recognize the income until she sold the stock.
C. Evelyn must recognize the stock as interest income.
D. Evelyn must include the fair market value of the shares in her ordinary income.
The answer is D. Since the fair market value of the is $4,000, she must include that amount in her income. Bartering is an exchange of property or services. Evelyn must include the FMV of property or services received in her gross income.
- When are advance rental payments taxable?
A. In the year they are received.
B. In the period in which they are accrued.
C. They are not taxable.
D. They are taxable when the checks are cashed.
The answer is A. Advance rental payments received under a lease must be recognized in the year received. This is true no matter what accounting method or period is used. This means that a taxpayer who owns rental properties and receives rent in advance cannot delay recognizing the income, even if the taxpayer is on the accrual basis.
- Harley is a real estate professional who owns two duplexes and an office building, all of which he rents to tenants. He works on his rental activity full-time. How should Harley report his rental income?
A. On Schedule E.
B. On Schedule C.
C. On Schedule D.
D. Harley’s rental income is not taxable because he is a real estate professional.
The answer is B. Normally, the IRS considers rental income as passive income, not subject to employment taxes, and it is reported on Schedule E, Supplemental Income and Loss. However, as a real estate professional, Harley’s income is not passive and is subject to employment taxes. He must report his rental income on Schedule C, Profit and Loss for Business.
- The Vitrano Tool Corporation rents large tools and machinery for use in construction projects. The company always charges a refundable security deposit and a nonrefundable cleaning deposit when someone rents a machine. Vitrano Tool Corporation received the following amounts in 2012:
Rental income $50,000
Security deposits $4,050
Cleaning deposits $1,500
What amount should be included in the corporation’s gross income?
A. $50,000.
B. $51,500.
C. $54,050.
D. $55,550.
The answer is B. The refundable security deposits are not taxable income, because those amounts are returned to the customer. The amount included in gross income would be the rental income and the nonrefundable cleaning deposits ($50,000 + $1,500 = $51,500).
- When is a business not required to realize income from a canceled debt?
A. Canceled debt is always taxable to a business.
B. A business does not have to realize canceled debt income to the extent that the payment of the debt would have led to a business deduction.
C. Canceled debt is is never taxable income to a business.
D. Canceled debt is realized income to a sole proprietorship, but not to a C corporation or an S corporation.
The answer is B. Canceled debt is not realized income to a business to the extent that the payment of the debt would have led to a business deduction. All of the other answers are incorrect.
- Camille, a calendar-year, accrual-based taxpayer, owns a studio that teaches ballroom dancing. On October 1, 2012, she receives payment for a one-year contract for 96 one-hour lessons beginning on that date. She gives eight lessons in 2012 and the rest in 2013. How and when must she recognize this payment as income?
A. All income must be recognized in 2012.
B. All income may be deferred until 2013 since that is when most of the lessons are given.
C. 8/96 of the income must be recognized in 2012 and the rest, 88/96, in 2013.
D. All of the income can be split equally between 2012 and 2012.
The answer is C. Under the rules of advance payment for services, Camille must recognize income from the eight lessons she gives in 2012 and recognize the rest in 2013, regardless of whether she actually has given all of the lessons by the end of 2013.
- Assume the same facts as in the previous questions, except the payments is for a two-year contract for 96 lessons. Camille gives eight lessons in 2012; 48 lessons in 2013; and 40 lessons in 2014. How and when must she recognize this payment as income?
A. All income must be recognized in 2012.
B. 8/96 of the income must be recognized in 2012; 48/96 in 2013; 40/96 in 2014.
C. 8/96 of the income must be recognized in 2012 and 88/96 in 2013.
D. All of the income can be deferred and split equally between 2013 and 2014.
The answer is A. Camille must include the entire payment in income in 2012 since some of the services may be performed after the following year.
