Chapter 5 Flashcards
Andre constructs and installs cabinets in homes. Blair sells and installs carpet in apartments. Andre and Blair worked out an arrangement whereby Andre installed cabinets in Blair’s home and Blair installed carpet in Andre’s home. Neither Andre nor Blair believes they are required to recognize any gross income on this exchange because neither received cash. Do you agree with them? Explain.
Both Andre and Blair are required to recognize gross income equal to the value of the goods and services they received. Reg. §1.61-(a) indicates that taxpayers realize income whether they receive money, property, or services in a transaction. That is, the form of the receipt does not matter. In this case, Andre should report gross income equal to the carpet he received and Blair should report gross income equal to the value of the cabinets he received.
Brad purchased land for $45,000 this year. At year-end Brad sold the land for $51,700 and paid a sales commission of $450. What effect does this transaction have on Brad’s gross income? Explain.
The sale increases Brad’s gross income by $6,250. The selling expenses reduce the amount realized on the sale from $51,700 to $51,250 and the $45,000 cost of the land is a return of capital. The excess of the amount realized over the cost is included in his gross income ($51,700 - $450 - $45,000 = $6,250).
For each of the following independent situations, indicate the amount the taxpayer must include in gross income and explain your answer:
a. Phil won $500 in the scratch-off state lottery. There is no state income tax.
b. Ted won a compact car worth $17,000 in a TV game show. Ted plans to sell the car next year.
c. Al Bore won the Nobel Peace Prize of $500,000 this year. Rather than take the prize, Al designated that the entire award should go to Weatherhead Charity, a tax-exempt organization.
d. Jerry was awarded $2,500 from his employer, Acme Toons, when he was selected most handsome employee for Valentine’s Day this year.
e. Ellen won a $1,000 cash prize in a school essay contest. The school is a tax-exempt entity, and Ellen plans to use the funds to pay her college education.
f. Gene won $400 in the office March Madness pool
a. All $500 is economic income realized this year and is, therefore, included in gross income.
b. The value of the car, $17,000, is economic income realized this year and is, therefore, included in gross income.
c. The entire award is excluded and therefore tax exempt. The award is excluded because it was for scientific, literary, or charitable achievement, and the taxpayer immediately transferred the award to a qualified charity.
d. All $2,500 is economic income realized this year and is, therefore, included in gross income.
e. All $1,000 is economic income realized this year and is, therefore, included in gross income.
f. Gene should include $400 in his gross income.
L. A. and Paula file as married taxpayers. In August of this year, they received a $5,200 refund of state income taxes that they paid last year. How much of the refund, if any, must L. A. and Paula include in gross income under the following independent scenarios? Assume the standard deduction last year was $24,800.
a. Last year L. A. and Paula had itemized deductions of $19,200, and they chose to claim the standard deduction.
b. Last year L. A. and Paula claimed itemized deductions of $32,200. Their itemized deductions included state income taxes paid of $7,500 and no other state or local taxes.
A. Because they did not itemize their deductions, L. A. and Paula received no benefit from the $5,200 tax overpayment. Hence, none of the refund is included in gross income.
B. L. A. and Paula received a tax benefit for the lesser of the refund ($5,200) or the excess of the itemized deductions above the standard deduction ($32,200-$25,900= $6,300). Hence, they must include the entire $5,200 refund in gross income.
For each of the following situations, indicate how much the taxpayer is required to include in gross income and explain your answer:
Steve was awarded a $5,000 scholarship to attend State Law School. The scholarship pays Steve’s tuition and fees.
b. Hal was awarded a $15,000 scholarship to attend State Hotel School. All scholarship students must work 20 hours per week at the school residency during the term.
A. The $5,000 scholarship is excluded from gross income because it is used to pay Steve’s tuition and fees.
b. The $15,000 scholarship is included in gross income because the terms of the scholarship require Hal to perform services.
This year, Leron and Sheena sold their home for $750,000 after all selling costs. Under the following scenarios, how much taxable gain does the home sale generate for Leron and Sheena?
Leron and Sheena bought the home three years ago for $150,000 and lived in the home until it sold.
Leron and Sheena bought the home 1 year ago for $600,000 and lived in the home until it sold.
$100,000. Because Leron and Sheena satisfy the 2-year ownership and 2-year use test, they may exclude up to $500,000 of gain from the sale of their home. Thus, Leron and Sheena may exclude $500,000 of the $600,000 gain ($750,000 - $150,000 = $600,000 realized gain) that they realized on the sale.
Because Leron and Sheena do not satisfy the 2-year ownership or 2-year use test, the entire $150,000 realized gain ($750,000 - $600,000= $150,000) is taxable.
Terry was ill for three months and missed work during this period. During his illness Terry received $4,500 in sick pay from a disability insurance policy. What amounts are included in Terry’s gross income under the following independent circumstances?
A. Terry has disability insurance provided by his employer as a nontaxable fringe benefit. Terry’s employer paid $2,800 in disability premiums for Terry this year.
B. Terry paid $2,800 in premiums for his disability insurance this year.
C. Terry’s employer paid the $2,800 in premiums for Terry, but Terry elected to have his employer include the $2,800 as compensation on Terry’s W-2.
D. Terry has disability insurance whose cost is shared with his employer. Terry’s employer paid $1,800 in disability premiums for Terry this year as a nontaxable fringe benefit, and Terry paid the remaining $1,000 of premiums from his after-tax salary.
A. $4,500. The disability pay of $4,500 is included in Terry’s gross income because Terry’s employer paid the insurance premiums as a nontaxable fringe benefit to Terry. Consequently, the disability insurance premiums of $2,800 paid by Terry’s employer are excluded from Terry’s gross income.
B. $0. The disability pay of $4,500 is excluded from Terry’s gross income because Terry paid the insurance premiums. Note: the cost of disability insurance premiums is not deductible as a medical expense.
C. $0. Even though his employer paid the premium, the premium is taxable compensation to Terry, so he is treated as though he paid the premiums. Thus, the answer is the same as for part b.
D. $2,893. A portion of the disability pay is excluded from Terry’s gross income because Terry paid a portion of the insurance premiums. Terry can exclude $1,607 = [($1,000/$2,800) * $4,500].
What amounts are included in gross income for the following taxpayers? Explain your answers.
A. Janus sued Tiny Toys for personal injuries from swallowing a toy. Janus was paid $30,000 for medical costs and $250,000 for punitive damages.
B. Carl was injured in a car accident. Carl’s insurance paid him $500 to reimburse his medical expenses and an additional $250 for the emotional distress Carl suffered as a result of the accident.
C. Ajax published a story about Pete and as a result Pete sued Ajax for damage to his reputation. Ajax lost in court and paid Pete an award of $20,000.
D. Bevis was laid off from his job last month. This month he drew $800 in unemployment benefits.
A. The $30,000 is excluded from Janus’s gross income because it is a payment for a physical injury. However, the $250,000 of punitive damages is included in Janus’s gross income because the payment is intended to punish Tiny Toys rather than compensate Janus for her injuries.
B. The reimbursed medical costs and the payment for emotional distress associated with a physical injury are excluded.
C. Pete must include the payments in gross income because the payments are not associated with a physical injury.
D. Bevis must include the unemployment benefits in his gross income because unemployment benefits are a replacement for lost wages.
