Income Inclusions & Exclusions

Question 1

Simba and Zola are married but file separate returns. Simba received $71,200 of salary and $4,300 of taxable dividends on stock he purchased in his name with the salary he earned since the marriage. Zola collected $2,200 in taxable interest on a certificate of deposit she inherited from her aunt.

Compute Zola’s gross income under two assumptions as to the state of residency of the couple.

Answer 1

a. Idaho (Community Property State)
Dividends: $2,150 (=$4,300 / 2 taxpayers)
Interest: $1,100 (=$2,200 / 2 taxpayers)
Salary: $35,600 (=$71,200 / 2 taxpayers)

b. South Carolina (Common Law State)
Dividends: None
Interest: $2,200
Salary: None

Question 2

Casper and Cecile divorced in 2018. As part of the divorce settlement, Casper transferred stock to Cecile. Casper purchased the stock for $195,000, and it had a market value of $312,000 on the date of the transfer. Cecile sold the stock for $273,000 a month after receiving it. In addition, Casper is required to pay Cecile $9,750 a month in alimony. He made five payments to her during the year.

a. How much gain or loss does Casper recognize on the transfer of the stock?
b. Does Casper receive a deduction for the $48,750 alimony paid?
c. How much income does Cecile have from the $48,750 alimony received?
d. When Cecile sells the stock, how much does she report?

Answer 2

a. Per tax laws, the transferor cannot record any gain or loss on the transfer of property at the time of divorce.
b. When couples are. legally separated, alimony payment is tax-deductible for the payer.
c. For divorces prior to 2019, alimony is included in gross income.
d. Cecile will report a gain of $78,000 (=$273,000 - 195,000).

Question 3

A taxpayer, age 64, purchases an annuity from an insurance company for $88,000. She is to receive $733 per month for life. Her life expectancy is 20.8 years from the annuity starting date. Assuming that she receives $8,800 this year, what is the exclusion percentage, and how much is included in her gross income?

a. Exclusion percentage
b. Included in income

Answer 3

a. Exclusion percentage: 48.10%

$88,000 annuity / (733 monthly disbursement x 12 months x 20.8 years)

b. Included in income: $4,567

$8,800 annual disbursement - (8,800 annual disbursement x 48.10% exclusion percentage)

Question 4

Tyler and Candice are married and file a joint tax return. They have adjusted gross income of $39,800 before considering their Social Security benefits, no tax-exempt interest, and $13,930 of Social Security benefits. As a result, how much of the Social Security benefits are taxable?

Answer 4

Their includible Social Security benefits will be $8,350, the lesser of the following:
1. 85%($13,930 Social Security benefits) = $11,841.
2. Sum of:
a. 85%[$39,800 + 1/2($13,930) − $44,000 higher threshold amount] = $2,350 and
b. Lesser of:
1. Amount calculated using the lower threshold amount, which is the lesser of:
• 50%($13,930 Social Security benefits) = $6,965.
• 50%[$39,800 + 1/2($13,930) − $32,000] = $7,383.
2. $6,000.

The sum equals $8,350 ($2,350 + $6,000). When compared to $11,841 (85% of the Social Security benefits received), the lesser of the two is included in the couple’s gross income.

Question 5

Assume Tyler and Candice have adjusted gross income of $18,600 before considering their Social Security benefits, no tax-exempt interest, and $20,460 of Social Security benefits. As a result, how much of the Social Security benefits are taxable?

Answer 5

The taxpayers must include $0 of the benefits in gross income. This is determined as the lesser of the following:

1. 50%($20,460 Social Security benefits) = $10,230.
2. 50%[$18,600 + 1/2($20,460) - $32,000] = 50% x ($3,170) = ($1,585). None of the benefits would be taxable because the result is not a positive number.

Question 6

Assume Tyler and Candice have adjusted gross income of $115,000 before considering their Social Security benefits, no tax-exempt interest, and $17,250 of Social Security benefits. As a result, how much of the Social Security benefits are taxable?

Answer 6

Their includible Social Security benefits will be $14,663, the lesser of the following:
1. 85%($17,250 Social Security benefits) = $14,663.
2. Sum of:
a. 85%[$115,000 + 1/2($17,250) - $44,000 higher threshold amount] = $67,681 and
b. Lesser of:
1. Amount calculated using the lower threshold amount, which is the lesser of:
• 50%($17,250 Social Security benefits)= $8,625.
• 50%[$115,000 + 1/2($17,250) - $32,000] = $45,813 or
2. $6,000.

The sum equals $73,681 ($67,681 + $6,000). Because 85% of the Social Security benefits received is less than this amount, only $14,663 is included in the couple’s gross income.

Question 7

Al is a medical doctor who conducts his practice as a sole proprietor. During 2021, he received cash of $577,400 for medical services. Of the amount collected, $43,200 was for services provided in 2020. At the end of 2021, Al had accounts receivable of $99,900, all for services rendered in 2021. In addition, at the end of the year, Al received $9,500 as an advance payment from a health maintenance organization (HMO) for services to be rendered in 2022.

a. Compute Al’s gross income for 2021 using the cash basis of accounting.
b. Compute Al’s gross income for 2021 using the accrual basis of accounting.
c. Advise Al on which method of accounting he should use.

Answer 7

a. $586,900

= $577,400 cash collected + 9,500 advance cash payment

b. $634,100

= $577,400 current year cash collected - 43,200 prior year A/R collected + 99,900 current A/R

c. Al should use the cash-basis of accounting so that he will not have to pay income taxes on the uncollected receivables.

Question 8

Leland pays premiums of $16,000 for an insurance policy in the face amount of $80,000 upon the life of Caleb and subsequently transfers the policy to Tyler for $24,000. Over the years, Tyler pays subsequent premiums of $4,800 on the policy. Upon Caleb’s death, Tyler receives the proceeds of $80,000.

As a result, what amount is Tyler required to include in his gross income?

Answer 8

$51,200

=$80,000 face value - 24,000 policy transfer amount - 4,800 policy premiums remaining

Question 9

Jarrod receives a scholarship of $28,000 from East State University to be used to pursue a bachelor’s degree. He spends $16,800 on tuition, $1,400 on books and supplies, $5,600 for room and board, and $4,200 for personal expenses.

How much may Jarrod exclude from his gross income?

Answer 9

$18,200

=$16,800 tuition + 1,400 books and supplies

Question 10

Apply the tax benefit rule to determine the amount of the state income tax refund included in gross income in 2021.

Myrna and Geoffrey filed a joint tax return in 2020. Their AGI was $88,825, and itemized deductions were $27,400, which included $6,850 in state income tax and no other state or local taxes. In 2021, they received a $5,480 refund of the state income taxes that they paid in 2020. The standard deduction for married filing jointly in 2020 was $24,800.

Answer 10

Lower of the state refund or itemized deductions less standard deduction

$27,400 - 24,800 = $2,600 which is lower than the state refund of $5,480. Therefore the answer is $2,600.

Question 11

Apply the tax benefit rule to determine the amount of the state income tax refund included in gross income in 2021.

Veronica filed as a single taxpayer in 2020. Her AGI was $239,000, and itemized deductions were $41,600. Her local property taxes were $13,800 and her state income taxes were $20,100. In 2021, Veronica received a $4,500 refund of the state income taxes she paid in 2020. The standard deduction for single filers in 2020 was $12,400.

Answer 11

None. If a taxpayer obtains a deduction for an item in one year and in a later year recovers all or a portion of the prior deduction, the recovery is included in gross income in the year received.

Question 12

George, age 74, is an officer of Blue Company, which provides him with the following nondiscriminatory fringe benefits in 2021:

• Hospitalization insurance premiums for George and his dependents. The cost of the coverage for George is $3,325 per year, and the additional cost for his dependents is $4,650 per year. The plan has a $2,000 deductible, but his employer contributed $1,500 to George’s Health Savings Account (HSA). George withdrew only $700 from the HSA, and the account earned $70 of interest during the year.
• Insurance premiums of $500 for salary continuation payments. Under the plan, George will receive his regular salary in the event he is unable to work due to illness. George collected $8,000 on the policy to replace lost wages while he was ill during the year.
• George is a part-time student working on his bachelor’s degree in engineering. His employer reimbursed his $4,500 tuition under a plan available to all full-time employees.

For each of the following items, enter the amount to be included in George’s gross income.

a. Hospitalization insurance premiums for George and his dependents.
b. Insurance premiums of. $500 for salary continuation payments.
c. The $8,000 George collected on the salary continuation policy to replace lost wages while he was ill during the year.
d. Tuition reimbursement under a plan available to all full-time employees.

Answer 12

a. Employer’s contributions to HSA are non-taxable and should not be included.
b. The beneficiary of the insurance premiums is the employer rather than the employee, therefore they are not included in gross income.
c. The amount received is a salary alternative therefore must be included in gross income.
d. Educational assistance reimbursed by employers is non-taxable by the student employee.

Question 13

Abbey spent the last 80 days of 2021 in a nursing home. The cost of the services provided to her was $22,000 ($275 per day). Medicare paid $6,000 toward the cost of her stay. Abbey also received $15,800 of benefits under a long-term care insurance policy she purchased. Assume that the Federal daily excludible amount is $400.

What is the effect on Abbey’s gross income?

Answer 13

The amount of her exclusion is $26,000 and the amount included in her gross income is $0.

Statutory amount: $400 daily excludable amount x 80 days in care = $32,000

Amount of exclusion: $32,000 statutory amount - $6,000 medicare portion = $26,000

The $26,000 exclusion exceeds the insurance payments of $15,800, therefore nothing is included in gross income.

Question 14

The annual increase in the cash surrender value of a life insurance policy:

a. Reduces the deduction for life insurance expense
b. Is not included in gross income because the policy must be surrendered to receive the cash surrender value
c. Is exempt because it is life insurance proceeds
d. Is taxed according to the original issue discount rules

Answer 14

Is not included in gross income because the policy must be surrendered to receive the cash surrender value

Question 15

With respect to the unearned income from services, which of the following is true?

a. An accrual basis taxpayer can spread the income over the period services are to be provided if all the services will be completed within three years following the year of receipt.
b. A cash-basis taxpayer must report all of the income in the year received.
c. An accrual-basis taxpayer can spread the income over the period services are to be provided on a contract for three years or less.
d. The treatment of unearned income is the same for tax and financial accounting for accrual-basis taxpayers.

Answer 15

A cash-basis taxpayer must report all of the income in the year received

Question 16

Under the terms of a divorce agreement entered into in 2017, Maria was to pay her wife Joyce $2,000 per month in alimony and $500 per month in child support. For a 12-month period, Maria can deduct from gross income (and Joyce must include in gross income):

a. $24,000
b. $6,000
c. $0
d. $30,000

Answer 16

$24,000

Question 17

Debbie is age 67 and unmarried. Her only sources of income are $200,000 in taxable interest and $20,000 of Social Security benefits. Debbie’s adjusted gross income for the year is:

a. $203,000
b. $220,000
c. $217,000
d. $200,000

Answer 17

$217,000

Question 18

Our tax laws encourage taxpayers to ____ assets that have appreciated in value and ____ assets that have declined in value.

a. keep; sell
b. sell; keep
c. keep; keep
d. sell; sell

Answer 18

keep; sell

Question 19

Sharon had some insider information about a corporate takeover. She unintentionally informed a friend, who immediately bought the stock in the target corporation. The takeover occurred and the friend made a substantial profit from buying and selling the stock. The friend told Sharon about his stock dealings and gave her a pearl necklace because she “made it all possible.” The necklace was worth $10,000, but she already owned more jewelry than she desired.

a. The value of the necklace is not included in Sharon’s gross income because passing the information was an illegal act and the SEC can confiscate the necklace.
b. The value of the necklace is not included in Sharon’s gross income unless she sells it.
c. The value of the necklace must be included in Sharon’s gross income for the tax year she received it.
d. The necklace is a nontaxable gift received by Sharon because the friend was not legally required to make the gift.

Answer 19

The value of the necklace must be included in Sharon’s gross income for the tax year she received it

Question 20

Jena is a full-time undergraduate student at State University and qualifies as a dependent of her parents. Her only source of income is a $10,000 athletic scholarship ($1,000, books; $5,500, tuition; $500, student activity fee; and $3,000, room and board). Jena’s gross income for the year is:

a. $10,000
b. $500
c. $4,000
d. $3,000

Answer 20

$3,000

Question 21

Christie sued her former employer for a back injury she suffered on the job in 2021. As a result of the injury, she was partially disabled. In 2022, she received $240,000 for her loss of future income, $160,000 in punitive damages because of the employer’s flagrant disregard for the employee’s safety, and $15,000 for medical expenses. The medical expenses were deducted on her 2021 return, reducing her taxable income by $12,000. Christie’s 2022 gross income from the above is:

a. $415,000
b. $225,000
c. $412,000
d. $172,000

Answer 21

$172,000

Question 22

Heather is a full-time employee of Drake Company and participates in the company’s flexible spending plan that is available to all employees. Which of the following is correct?

a. Heather reduced her salary by $1,200 and received only $800 as reimbursement for her medical expenses. She is not refunded the $400. Her gross income is reduced by $800.
b. Heather reduced her salary by $1,200 and received only $900 as reimbursement for her actual medical expenses. She is not refunded the $300 remaining balance, but her gross income is reduced by $1,200.
c. Heather reduced her salary by $1,200 and received only $900 as reimbursement for her medical expenses. She forfeits the $300. Her gross income is reduced by $300.
d. Heather reduced her salary by $1,200, actually spent $1,500, and received only $1,200 as reimbursement for her medical expenses. Heather’s gross income will be reduced by $1,500.

Answer 22

Heather reduced her salary by $1,200 and received only $900 as reimbursement for her actual medical expenses. She is not refunded the $300 remaining balance, but her gross income is reduced by $1,200.

Question 23

Margarita’s interest and gains on investments for the current year are as follows:

$600 - Interest on Madison County school bonds

$700 - Interest on U.S. government bonds

$200 - Interest on a Federal income tax refund

$500 - Gain on the sale of Madison County school bonds

Margarita must report gross income in the amount of:

a. $1,800
b. $2,000
c. $1,400
d. $1,300

Answer 23

$1,400