STUDY UNIT THREE INDIVIDUAL TAXATION AND GROSS INCOME

Question 1

A payment by a taxpayer to a former spouse pursuant to an agreement executed in 2014 may qualify as alimony even though
A The payment is made to keep up the taxpayer’s property.
B The payment is to a third party.
C The payment is designated as child support.
D The liability to make the payment would survive the recipient spouse’s death.

Answer 1

B The payment is to a third party.
This answer is correct.
Payments of cash to a third party made at the written request of the payee spouse will qualify as alimony. Payments are often made on behalf of the payee spouse, such as payments for mortgages, rent, medical costs, or education.

Question 2

Randolph is a single individual who always claims the standard deduction. Randolph received the following in the current year:
Wages $22,000
Unemployment compensation 6,000
Pension distribution (100% taxable) 4,000
A state tax refund from the previous year 425
What is Randolph’s gross income?
A $32,000
B $22,000
C $28,425
D $32,425

Answer 2

A $32,000
This answer is correct.
Wages, unemployment compensation, and fully taxable pension distributions are all included in gross income. Since Randolph always claims the standard deduction, he would not take the deduction for state taxes paid and would not have to include the refund in this year’s gross income.

Question 3

Scholarships and fellowships awarded to degree candidates are not taxable unless they are used for
A Room and board.
B Books.
C Supplies required for the course of study.
D Tuition.

Answer 3

A Room and board.
This answer is correct.
The IRC provides an exclusion from gross income for amounts received as a scholarship or fellowship grant by a degree candidate. But only amounts provided and actually used for tuition, fees, books, supplies, and equipment required for instruction qualify for this exclusion. Room and board does not qualify.

Question 4

In 2014, Sam received the following corporate distributions:

I $1,500 dividend on stock held in a public corporation that offers a dividend reinvestment plan that lets him choose to use the dividend to buy (through an agent) more stock in the corporation at a price equal to its fair market value instead of receiving the dividends in cash. Sam chose to take part in the plan.
II $2,500 dividend on stock held in a public corporation that offers a dividend reinvestment plan that lets him choose to use the dividend to buy (through an agent) more stock in the corporation at a price less than its fair market value. The fair market value of shares Sam purchased through the plan on the dividend payment date in 2014 was $3,000.
III $2,000 return of capital distribution reported on Form 1099-DIV.

Based on the above information, how much ordinary dividend income must Sam report on his 2014 return?
A $6,500
B $6,000
C $4,500
D $4,000

Answer 4

C $4,500
This answer is correct.
Dividends are gross income. A shareholder who, under a dividend reinvestment plan, elects to receive shares of greater value than his or her cash dividend would otherwise be receives a taxable distribution to the extent of the value of the shares. The distribution is generally a taxable dividend to the extent of the corporation’s earnings and profits. Sam’s gain is $4,500 ($3,000 + $1,500) because the gain must equal the FMV of the shares purchased. The return of capital distribution is a tax-free distribution that reduces a stock’s basis by the amount of the distribution.

Question 5

During 2014, Kay received interest income as follows:
On U.S. Treasury certificates $4,000
On refund of 2013 federal income tax 500
The total amount of interest subject to tax in Kay’s 2014 tax return is
A $500
B $4,500
C $0
D $4,000

Answer 5

B $4,500
This answer is correct.
Unless specifically excluded by the IRC, interest is included in gross income. Although interest on most obligations of a state or political subdivisions of a state are excluded from gross income, this exclusion does not apply to obligations of the U.S. if not a Series EE bond. Furthermore, interest earned on federal tax refunds is not excluded from gross income.

Question 6

Baker, an unmarried individual, sold a personal residence, which has an adjusted basis of $70,000, for $165,000. Baker owned and lived in the residence for 7 years. Selling expenses were $10,000. Four weeks prior to the sale, Baker paid a handyman $1,000 to paint and fix-up the residence. What is the amount of Baker’s recognized gain?
A $85,000
B $95,000
C $84,000
D $0

Answer 6

D $0
This answer is correct.
While the correct amount of realized gain is $85,000, IRC Sec. 121 excludes the gain on the sale of a principal residence, up to $250,000 per taxpayer, subject to certain rules and limitations. As none of the facts would lead us to reduce this exclusion, no gain is recognized on the disposition of the home.

Question 7

During Year 3, Ruth Loy received interest income as follows:
On U.S. Treasury certificates $3,000
On refund of Year 1 federal income tax 200
The total amount of interest subject to tax in Ruth’s Year 3 return is
A $3,000
B $0
C $200
D $3,200

Answer 7

D $3,200
This answer is correct.
Interest is a form of income from whatever source derived. Since no provision provides for exclusion of interest on U.S. Treasury certificates other than Series EE bonds, it must be included in gross income. Interest on governmental obligations is only exempt for state and local entities. Interest on refunds of federal income tax is also not excluded from gross income.

Question 8

During 2014, Clark received the following interest income:
On Veterans Administration insurance
dividends left on deposit with the V.A. $20
On state income tax refund 30
What amount should Clark include for interest income in his 2014 return?
A $20
B $50
C $30
D $0

Answer 8

C $30
This answer is correct.
Interest income is included in gross income unless specifically excluded by an IRC section. Although an exclusion for interest on certain obligations of states and municipalities is provided, it does not apply to interest on state income tax refunds. The interest on V.A. insurance dividends left on deposit with the V.A. is excluded from gross income.

Question 9

Major, a candidate for a graduate degree, received the following scholarship awards from the university in 2014:

$10,000 for tuition, fees, books, and supplies required for courses
$2,000 stipend for research services required by the scholarship

What amount of the scholarship awards should Major include as taxable income in 2014?
A $0
B $12,000
C $2,000
D $10,000

Answer 9

C $2,000
This answer is correct.
Excluded from gross income are any amounts received by a candidate for a degree at an educational organization as a scholarship or grant but only to the extent that such amounts are used for tuition, fees, books, supplies, and equipment. This exclusion does not include payments for teaching, research, or other services by the student required as a condition for receiving the scholarship. Also, this exclusion does not apply if past, present, or future services are a condition of the scholarship. The $2,000 payment, which requires research services, must be included in Major’s gross income.

Question 10

During 2014, Ash had the following cash receipts:
Wages $15,000
Interest income from U.S. Treasury bonds 350
Workers’ compensation following a job-related injury 8,500
What is the total amount that must be included in gross income on Ash’s 2014 income tax return?
A $15,350
B $23,500
C $15,000
D $23,850

Answer 10

A $15,350
This answer is correct.
Wages are included in gross income. Also, unless specifically excluded by the IRC, interest is included in gross income. Although interest on most obligations of a state or political subdivision of a state are excluded from gross income, this exclusion does not typically apply to obligations of the U.S. There is no indication that any of Ash’s interest is excludable as interest from a Series EE bond used for education expenses. Specifically excluded from gross income are amounts received under workers’ compensation acts as compensation for personal injuries or sickness. Therefore, Ash’s gross income for 2014 is $15,350 ($15,000 wages + $350 interest income).

Question 11

Household maintenance expenses for head of household status include upkeep and property tax, but not clothing and medical treatment.

True.
False.

Answer 11

True.
Your answer is correct.
Maintenance expenses include property tax, mortgage interest, rent, utilities, upkeep, repair, property insurance, and food consumed on premises. Nonqualifying costs are clothing, education, medical treatment, life insurance, transportation, vacations, services by the taxpayer, and services by the dependent.

Question 12

The amount of each exemption that an individual may claim is phased out if the individual’s AGI exceeds a threshold amount.

True.
False.

Answer 12

True.
Your answer is correct.
The amount of each exemption that an individual could claim was phased out if the individual’s AGI exceeds a threshold amount.

Question 13

The IRC (Internal Revenue Code) defines gross income (GI) as all income from whatever source derived except as otherwise provided.

True.
False.

Answer 13

True.
Your answer is correct.
The Internal Revenue Code (IRC) defines gross income (GI) as all income from whatever source derived except as otherwise provided. Section 61(a) enumerates types of income that constitute gross income. The following list is not exhaustive: compensation for services, gross income derived from business, gains derived from dealings in property, interest, rents, royalties, dividends, alimony and separate maintenance payments, annuities, income from life insurance and endowment contracts, pensions, income from discharge of indebtedness, distributive share of partnership gross income, income in respect of a decedent (income earned but not received before death), and income from an interest in an estate or trust.

Question 14

In computing gain on disposal of investment property, historical cost indicates the amount of capital invested in the property and not yet recovered by tax benefit (i.e., depreciation).

True.
False.

Answer 14

False.
Your answer is correct.
In computing gain on disposal of investment property, adjusted basis indicates the amount of capital invested in the property and not yet recovered by tax benefit (i.e., depreciation).

Question 15

As a result of a divorce, a taxpayer received the following during the current year:
Cash from the property settlement $100,000
Child support 12,000
Alimony payments 30,000
What amount, if any, must be included in gross income for the current year?

A. $30,000
B. $130,000
C. $142,000
D. $0

Answer 15

A. $30,000
Answer (A) is correct.
Alimony payments are included in gross income. Child support and property settlements are not.
(3.3.54)

Question 16

Thompson’s spouse died in Year 1. Thompson did not remarry in Year 2 and lived alone the entire year. What is Thompson’s Year 2 filing status?

A. Single.
B. Head of household.
C. Married filing jointly.
D. Surviving spouse.

Answer 16

A. Single.
Answer (A) is correct.
When the taxpayer does not qualify for any other filing status, he or she files as single. Thompson does not qualify for any other filing status, so he must file as single.
(3.1.9)

Question 17

Gifts are excluded from the gross income of the recipient.

True.
False.

Answer 17

True.
Your answer is correct.
The IRC provides for exclusion from the gross income of the recipient the value of property acquired by gift. Voluntary transfers from employer to employee are presumed to be compensation, not gifts.

Question 18

Amounts received by an individual as scholarships or fellowships and used for required tuition or fees, books, supplies, or equipment are included in gross income.

True.
False.

Answer 18

False.
Your answer is correct.
Amounts received by an individual as scholarships or fellowships are excluded from gross income to the extent that the individual is a candidate for a degree from a qualified educational institution, and the amounts are used for required tuition or fees, books, supplies, or equipment (not personal expenses).

Question 19

A pro rata distribution of common stock to common stock shareholders is excluded from gross income, while all other stock dividends are included in gross income.
True.
False.

Answer 19

True.
Your answer is correct.
The general rule is that a pro rata distribution of common stock to common stock shareholders is excluded from gross income, while all other stock dividends are included in gross income.

Question 20

The value of improvements made by the real property lessee is excludable by the lessor unless the lessee provided the improvements in lieu of rent.
True.
False.

Answer 20

True.
Your answer is correct.
The value of improvements made by the real property lessee is excludable by the lessor unless the lessee provided the improvements in lieu of rent. Income realized by the lessor from the improvements subsequent to termination of the lease is included. Additionally, amounts received by a retail lessee as cash or rent reductions are not included in gross income if used for qualified construction or improvements to the retail space.

Question 21

A taxpayer may exclude up to $250,000 ($500,000 for married taxpayers filing jointly) of realized gain on the sale of any residence.
True.
False.

Answer 21

False.
Your answer is correct.
A taxpayer may exclude up to $250,000 ($500,000 for married taxpayers filing jointly) of realized gain on the sale of a principal residence.

Question 22

Mr. Cypress owned a small three-unit apartment building in Detroit, Michigan. The rent on each apartment was $1,000 per month. During 2014, he received the following payments:
Apt. A - Timely rent payments were made for 12 months.
Apt. B - The apartment was vacant in January and February. On 3/1/14, a new tenant entered into a 1-year lease from 3/1/14 through 2/29/15. The tenant paid first and last month’s rent and a security deposit of $1,500. The security deposit is to be returned at the end of the lease if the tenant lives up to the terms of the lease. The tenant timely paid the rent for the next 9 months (April through December) on the first of each month.
Apt. C - In December, after timely paying the rent for 12 months of the year, the tenant came to Mr. Cypress and told him that he had been transferred to a new job location in Tennessee. He asked to be released from his 2-year lease obligation, which was scheduled to expire on June 30, 2015. Mr. Cypress agreed to accept 3 months’ rent to cancel the lease. The tenant paid Mr. Cypress $3,000 to cancel the lease in December.
Assuming Mr. Cypress is a cash-basis taxpayer, what amount should Mr. Cypress include in his 2014 gross income from the apartment building?
A $38,000
B $35,500
C $39,500
D $35,000

Answer 22

A $38,000
This answer is correct.
Both cash- and accrual-basis taxpayers must include amounts in gross income upon actual or constructive receipt if the taxpayer has an unrestricted claim to such amounts. Thus, all the rent payments should be included in the current year’s gross rental income. Security deposits are income only if the lessor becomes entitled to the funds because of the lessee’s violation of the terms of the lease. Therefore, Mr. Cypress does not have an unrestricted claim to the security deposit. The cancelation payment is in lieu of rent, so it must be included in income like rent. Mr. Cypress should recognize $12,000 from Apt. A ($1,000 rent × 12 months) plus $11,000 from Apt. B ($10,000 for rent + $1,000 last month’s rent) plus $15,000 from Apt. C ($12,000 rent + $3,000 cancelation payment), for a total of $38,000.
View Subunit 3.3 Outline

Question 23

Calvin and Gloria were divorced in a prior year. As part of the final divorce decree of the court, Calvin was ordered to pay $500 a month toward the support of his two children, Robert and Myra. During 2014, Calvin got 6 months behind in his child support payments. As a result of his delinquency, two things happened in 2014 to allow Calvin to catch up in his payments.

Gloria had Calvin’s wages garnished for $1,000 to pay 2 delinquent months’ child support.
Calvin, a cash-basis taxpayer, was due $2,000 for past work he had done for the XYZ Corp. He told the XYZ Corp. to pay the $2,000 directly to Gloria to make up 4 months’ child support. The XYZ Corp. paid the money directly to Gloria. 

Which of the following statements is true?
A Calvin did not receive any constructive income in 2014 when the $1,000 wages were garnished and the $2,000 income was paid directly to Gloria.
B Calvin constructively received both the $1,000 wages and the $2,000 income in 2014.
C Calvin constructively received the $1,000 wages but not the $2,000 income in 2014.
D Calvin constructively received the $2,000 income but not the $1,000 wages in 2014.

Answer 23

B Calvin constructively received both the $1,000 wages and the $2,000 income in 2014.
This answer is correct.
Income, although not actually in a taxpayer’s possession, is constructively received in the taxable year during which it is credited to his or her account, set apart for him or her, or otherwise made available so that (s)he may draw upon it at any time, or so that (s)he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. Calvin earned the wages in 2014, and they were used to fulfill an obligation. In this case, it does not matter that he did not have access to the funds. They were still constructively received in 2014.
View Subunit 3.3 Outline

Question 24

In February 2014, Paul and Jean, a married couple, cashed a qualified Series EE savings bond they bought in November 2003. They received proceeds of $7,132, representing principal of $5,000 and interest of $2,132. In 2014, they helped pay their daughter’s college tuition. The qualified education expenses they paid in 2014 totaled $4,000. They are not claiming an education credit for the expenses, and they do not have an education IRA. How much interest income can Paul and Jean exclude?
A $4,000
B $2,132
C $1,196
D $1,000

Answer 24

C $1,196
This answer is correct.
An exclusion from gross income is provided for interest on Series EE United States Savings Bonds used to finance the higher education of a taxpayer, a spouse, or a dependent. Accrued interest is excluded, provided the aggregate redemption proceeds (principal and interest) do not exceed the qualified higher educational expenses incurred during the same year as the redemption. If the gross proceeds are greater than the educational expenses, the amount of interest that is excludable is determined by taking the applicable fraction of interest. The applicable fraction is determined by dividing the total qualified educational expenses by the gross proceeds of the bond redemption ($4,000 ÷ $7,132). This percentage is then multiplied by the amount of interest to obtain the exclusion amount ($2,132 × .561). Therefore, Paul and Jean can exclude $1,196 of interest from income.
View Subunit 3.5 Outline

Question 25

Blake, a single individual, age 67, had a 2015 adjusted gross income of $60,000 exclusive of Social Security benefits. Blake received Social Security benefits of $8,400 and interest of $1,000 on tax-exempt obligations during 2015. What amount of Social Security benefits must be included in Blake’s 2015 taxable income?

A. $8,400
B. $7,140
C. $0
D. $4,200

Answer 25

B. $7,140
Answer (B) is correct.
Provisional income ($65,200) exceeded the adjusted base amount ($34,000) by $31,200. Since 85% of this excess plus 50% of Social Security benefits equals $30,720 ($26,520 + $4,200), which exceeds 85% of the total Social Security benefits ($7,140), the latter amount is included.
(3.4.58)

Question 26

All of the following statements are true except

A. A son, age 21, was a full-time student who earned $4,000 from his part-time job. The money was used to buy a car. Even though he earned $4,000, his parents can claim him as a dependent if the other exemption tests were met.
B. A brother-in-law must live with the taxpayer the entire year to be claimed as a dependent even if the other tests are met.
C. For each person claimed as a dependent, the Social Security number, adoption taxpayer identification number, or individual taxpayer identification number must be listed.
D. If a married person files a separate return, (s)he can take an exemption for his or her spouse if the spouse had no gross income and was not the dependent of another taxpayer.

Answer 26

B. A brother-in-law must live with the taxpayer the entire year to be claimed as a dependent even if the other tests are met.
Answer (B) is correct.
The relationship requirement is satisfied by existence of an extended (by blood) or immediate (by blood, adoption, or marriage) relationship. The relationship need be present to only one of the two married persons who file a joint return. Any relationship established by marriage is not treated as ended by divorce or by death. An individual must satisfy either a relationship or a domicile requirement but does not have to satisfy both.
(3.2.19)

Question 27

Willie Coconut was injured during the year and was not able to work due to his injury and the associated emotional distress. Willie received the following payments during the year:
Disability pay $3,500
Accident insurance proceeds (substitute for lost income) 7,000
Damages for emotional distress received by a lawsuit 2,000
Punitive damages 5,000
Willie has paid the premiums for all of his policies and has not taken any deductions for the medical expenses. The total amount of compensation for injury that Willie may exclude from gross income is

A. $3,500
B. $12,500
C. $17,500
D. $5,500

Answer 27

B. $12,500
Answer (B) is correct.
Gross income does not include benefits specified that might be received in the form of disability pay, health or accident insurance proceeds (even if the benefits are a substitute for lost income), workers’ compensation awards, or other damages for personal physical injury or physical sickness. Also excluded are damages received for emotional distress if an injury has its origin in a physical injury or physical sickness (regardless of whether the damages are received by a lawsuit or an agreement). However, punitive damages received are includible in gross income even if in connection with a physical injury or physical sickness. Thus, Willie may exclude $12,500 from gross income ($3,500 + $7,000 + $2,000).
(3.5.81)

Question 28

In which of the following situations will a controlled foreign corporation located in Ireland be deemed to have Subpart F income?

A. Property is bought from the controlled foreign corporation’s U.S. parent and is sold by an Irish company for use in an Irish manufacturing plant.
B. Property is produced in Ireland by the Irish company and sold outside its country of incorporation.
C. Services are provided by an Irish company in England under a contract entered into by its U.S. parent.
D. Services are performed in Ireland by the Irish company under a contract entered into by its U.S. parent.

Answer 28

C. Services are provided by an Irish company in England under a contract entered into by its U.S. parent.
Answer (C) is correct.
Section 954 of Subpart F defines foreign base company income (which is a component of Subpart F income) as including foreign base company services income. Foreign base company services income is income derived from the performance of a service of a skill on behalf of a related party and performed outside of the country of incorporation of the foreign subsidiary. Taxing Subpart F income ensures that companies cannot defer income tax by setting up corporations in low tax jurisdictions.
(3.3.55)

Question 29

Charles and Marcia are married cash-basis taxpayers. In 2015, they had interest income as follows:

$500 interest on federal income tax refund
$600 interest on state income tax refund
$800 interest on federal government obligations
$1,000 interest on state government obligations

What amount of interest income is taxable on Charles and Marcia’s 2015 joint income tax return?

A. $1,100
B. $1,900
C. $500
D. $2,900

Answer 29

B. $1,900
Answer (B) is correct.
Unless otherwise excluded in another section, the IRC includes interest in gross income. The IRC excludes from gross income interest on most obligations of states or political subdivisions of a state (e.g., municipal bonds). This exclusion does not apply to the obligations of the United States (with the exception of EE bonds used for qualifying education expenses) or interest on state income tax overpayments. Interest income is taxable unless specifically excluded from gross income.
(3.5.72)

Question 30

Sam and Ann Hoyt filed a joint federal income tax return for the calendar year 2015. Among the Hoyts’ cash receipts during 2015 was the following: $6,000 first installment on a $75,000 life insurance policy payable to Ann in annual installments of $6,000 each over a 15-year period, as beneficiary of the policy on her uncle, who died in 2014. What portion of the $6,000 installment on the life insurance policy is excludable from 2015 gross income in arriving at the Hoyts’ adjusted gross income?

A. $6,000
B. $1,000
C. $0
D. $5,000

Answer 30

D. $5,000
Answer (D) is correct.
Proceeds under a life insurance contract paid by reason of death of the insured are excluded from gross income. But the amount of each payment in excess of the death benefit prorated over the period of payment ($75,000 ÷ 15 years = $5,000/year) is interest income ($6,000 – $5,000), which is included in gross income
(3.5.68)

Question 31

In 2015, Joan accepted and received a $10,000 award for outstanding civic achievement. Joan was selected without any action on her part, and no future services are expected of her as a condition of receiving the award. What amount should Joan include in her 2015 gross income in connection with this award?

A. $4,000
B. $0
C. $10,000
D. $5,000

Answer 31

C. $10,000
Answer (C) is correct.
Prizes and awards made primarily in recognition of charitable, scientific, educational, etc., achievement are excluded from gross income only if the recipient was selected without any action on his or her part, is not required to render substantial future services as a condition of receiving the prize or award, and assigns it to charity. Thus, Joan cannot exclude any amount of the $10,000 award from gross income since she failed to assign it to charity.
(3.5.69)

Question 32

Larson Corp. paid $235 in premiums on a $49,000 nondiscriminatory group permanent life insurance policy for Jerry Michelle is named as beneficiary under the policy. What amount does she include in gross income?

Answer 32

$235. An employee may exclude the cost of up to $50,000 in coverage of group life insurance provided by the employer. The exclusion applies only to term, not permanent, insurance. Thus, the cost of this policy must be included in gross income.

Question 33

Michelle received $500 in interest on a loan to an unrelated third party. The loan was arranged by a mutual acquaintance. Under state law, the $75 over $425 in usurious and unenforceable. How much does Michelle include in gross income?

Answer 33

$500. Interest is gross income. Illegal income and interest in excess of the legal rate (e.g., usurious) are also income

Question 34

Jerry and Michelle received a $375 refund on state income taxes, plus $15 in interest on the amount. Jerry and Michelle’s federal income tax liability for 2014 was reduced as a result of deducting $375 paid to state. How much should Jerry and Michelle include in gross income?

Answer 34

$390. Recovery of previously paid taxes is excluded from prior income only if the prior deduction did not reduce the taxpayer’s federal income tax. The Sec. 103 exclusion of interest on certain obligations of states does not apply to tax overpayments

Question 35

Jerry received a gift of $400 in cash and $100 in gift certificates from his employer. How much should Jerry include in gross income?

Answer 35

$500. Gifts are generally excluded from gross income. Voluntary transfers from employer to employee are presumed to be compensation (TI), not gifts. Note that this was a gift and not an award. The $100 in gift certificates is the equivalent of cash.