R1 - Federal Taxation of Individuals

Question 1

Interest Income Taxation and Tax Benefit Rule

Answer 1

• Interest income, except from state and local government bonds, is fully taxable.
• If state income taxes were not itemized in the previous year’s return, any refund isn’t taxable this year.
• Tax benefit rule exempts the refund from taxation if state taxes weren’t deducted in the prior year.

Question 1

Alimony vs. Child Support Tax Treatment

Ex: John and Mary were divorced in 2017. The divorce decree (executed June 30, 2017) provides that John pay alimony of $10,000 per year, to be reduced by 20 percent on their child’s 18th birthday. During the current year, the $10,000 was paid in the following way: John paid $7,000 directly to Mary and $3,000 to Spring College for Mary’s tuition. What amount of these payments should be reported as income in Mary’s current year income tax return?

Answer 1

• Alimony paid from a divorce/separation before Dec. 31, 2018, is taxable income for the recipient.
• Child support payments are not taxable income for the recipient.
• For funds to qualify as child support:
  1. A specific amount must be fixed or contingent on child’s status.
  2. Payment must be solely for the support of minor children.
  3. Payment must be made by decree, instrument, or agreement.
• Actual use of the funds is irrelevant.
• In the example, $2,000 (20% of $10,000) qualifies as child support; the remaining $8,000 is alimony, taxable to the recipient.
• Note: For agreements executed after Dec. 31, 2018, alimony isn’t taxable to the recipient nor deductible by the payer.

Question 2

Taxation of Prizes and Awards

Answer 2

• Generally, prizes and awards’ fair market value is taxable income.
• Exception: Exclusion from income applies if:
  I. The winner is selected for the award without entering a contest (no action on the individual’s part).
  II. The award is assigned directly to a governmental unit or charitable organization.
• Both conditions “I” and “II” must be met for the exclusion to apply.

Question 3

Tax Treatment of Scholarship and Teaching Income

Answer 3

Scholarships are nontaxable for degree-seeking students if used for tuition, fees, books, and supplies.

Teaching income is included in gross income.

Question 4

Definition of Accruable Expense

Answer 4

An accruable expense is one is which the services have been received/performed but have not been paid for by the end of the reporting period.

Question 5

A cash basis taxpayer should report gross income:

Answer 5

for the year in which income is either actually or constructively received, whether in cash or in property.

Question 6

Employee Gross Income Inclusions and Exclusions

Answer 6

Inclusions:
- Awards, such as a $2,000 trip, are generally included in an employee’s gross income.
Exclusions:
- Premiums paid by an employer for up to $50,000 of group term life insurance coverage are generally excluded.
- Educational payments by an employer, up to $5,250, can be excluded from gross income for both undergraduate and graduate studies.
- The value of employer-provided parking, up to $300 per month, may be excluded from an employee’s gross income.

Question 7

Accounting for Noncash Services Exchanged

Ex: A painter and an accountant agree to trade their services. The painter provides services valued at $550, and the accountant provides services worth $500. What amount should the accountant report as income or expense?

Answer 7

• In the case of noncash income, the amount of income to be reported is the fair market value of the property or services received.
• Since the accountant received services valued at $550, the account must report income of $550.

Question 8

Taxable Employee Fringe Benefit: Company Car Use

Answer 8

• The value of using a company car is a taxable employee fringe benefit.
• If Carson, the employee, receives this benefit from his employer, it’s taxable regardless of who uses the car, including his spouse, Mary.
• However, Mary, who is not an employee of the company, doesn’t incur tax on the use of the company car, even if she’s the one utilizing it.

Question 9

Understanding Gross Income Components

Answer 9

Gross income includes:
- Non-cash fringe benefits from employers, like fair rent value of lodging.
- Treasure troves, including cash found unexpectedly.
- Employee achievement awards not as tangible property.
Inheritances generally not included.