Chapter 3
1. Connie was walking her dog when she came across a paper bag with $20,000 in it. She turned the money into the
police. After the appropriate period of time, no one claimed the money and the police returned the money to Connie.
Connie does not have to recognize any taxable income since it was not derived from capital or labor.
a.
True
b.
False
False
2. According to the U.S. Supreme Court, income may be defined as the gain derived from capital, from labor, or from
both combined provided it is understood to include profit gained through sale or conversion of capital assets.
a.
True
b.
False
True
3. Rachael purchased 300 shares of Smelt, Inc. stock for $25 per share. At the end of the year, the stock price has risen to
$30 per share. Rachael does not recognize taxable income even though there has been a $1,500 increase in wealth.
a.
True
b.
False
True
4. Julian is operating an illegal gambling operation. Even though the income is not legal, it is classified as earned.
a.
True
b.
False
True
5. An accrual basis taxpayer does not have income until there is an actual or constructive receipt of income earned.
a.
True
b.
False
False
6. Ruth purchased an annuity contract for $10,000. When she turns 65, she will receive $150 a month for the rest of her
life. The first $10,000 she receives is a return of her capital and is not taxable.
a.
True
b.
False
False
7. For any unrecovered portion of an annuity investment, the taxpayer is allowed a deduction in the year of death.
a.
True
b.
False
True
8. Ron won a $25,000 award for his research in microbiology and he immediately transferred the prize to his brother who
does similar research. The income is excluded from Ron’s taxable income.
a.
True
b.
False
False
9. Brandon and Judy divorce during the year and agree that Brandon will pay Judy $24,000 a year in alimony. Brandon
Chapter 3
will be able to reduce his income by $24,000, but Judy does not have to report any income since it was not earned..
a.
True
b.
False
False
10. Terry owns 100% of Terry Manufacturing, Inc, and has the corporation pay his son’s college tuition. Terry must
include the payments in his taxable income.
a.
True
b.
False
True
11. The holding period for receiving long-term capital gain treatment is 12 months or more.
a.
True
b.
False
False
12. Net collectibles gains are taxed at a maximum rate of 25 percent.
a.
True
b.
False
False
13. Mercedes has a net long-term capital gain of $3,000 and a net short-term capital loss of $10,000. She can deduct
$3,000 of the $7,000 net loss as a deduction for adjusted gross income in the current year. She must defer realizing any tax
benefit from the remaining $4,000 loss until the next year.
a.
True
b.
False
True
14. Friendly Finance loans Anne $10,000 and she will pay $13,130 at he end of three years. Since Friendly is on a cash
basis, it will recognize the $3,130 interest income when the loan is repaid.
a.
True
b.
False
False
15. The hybrid method of accounting provides that taxpayers will account for sales of merchandise and the related cost of
goods sold on the accrual basis and all other items of income and expense on the cash basis.
a.
True
b.
False
True
16. Income realization may occur as a result of
Relief from a liability.
Exchange of property.
Payment of the taxpayer’s indebtedness by another.
A barter transaction where only goods and services are exchanged.
a.
Only statement I is correct.
b.
Only statement II is correct.
Chapter 3
c.
Only statements I and IV are correct.
d.
Only statements I, II, and IV are correct.
e.
Statements I, II, III, and IV are all correct.
e
17. Which of the following constitutes a realization?
Jamie prepares a will for Wilson. He pays her by painting her house.
Jones’ cow gives birth. The calf will become a member of Jones’ feeder cattle herd.
Oak Ridge Coal Company’s coal mine reserves were recently appraised at $5,750,000 more
than the previous year’s appraisal.
Lea’s employer gives her (and all other salaried employees) a weekend in Orlando in
recognition of their efforts to make this a successful year.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Only statements I and II are correct.
d.
Only statements I and IV are correct.
e.
Only statements II, III, and IV are correct.
18. Which of the following constitutes a realization?
I.
Frank’s lakeside cottage is damaged in a violent storm. The cost of repairs totaled $4,000.
However, the insurance company gives Frank only $2,500 for the repairs.
II.
McDonald’s cow gives birth. The calf will become a member of McDonald’s feeder cattle
herd.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
a
19. Which of the following constitutes a realization?
I.
Oak Ridge Coal Company’s coal mine reserves were recently appraised at $5,750,000 more
than the previous year’s appraisal.
II.
Lea’s employer gives her (and all other salaried employees) a weekend in Chicago in
recognition of their efforts to make this a successful year.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
20. Carlotta finds a chest inscribed “Sinbad” that contains $250,000 of cash while diving among the coral reefs off the
Virgin Islands. The US Customs and the DEA deny knowledge of the cash, so Carlotta keeps it.
I.
Carlotta would not recognize any gross income if the chest contained jewels valued at
$250,000, rather than the cash.
II.
Recognition is necessary because Carlotta has an increase in wealth.
Chapter 3
III.
Recognition will not occur because the windfall would not be considered as derived from
capital or from labor.
IV.
The All-inclusive Income Concept explains the recognition of the cash as income.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Only statements I and IV are correct.
d.
Only statements I, II, and IV are correct.
e.
Only statements II, III, and IV are correct.
21. Marta finds a chest inscribed “Jack Sparrow” that contains $750,000 of cash while diving among the coral reefs off
Key West, Florida. The US Customs and the DEA denied knowledge of the cash, so Marta keeps it.
I.
Recognition will not occur because the windfall would not be considered as “derived from
capital or from labor.”
II.
The All-inclusive Income Concept explains the recognition of the cash as income.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
22. Sophi finds a chest inscribed “Captain Hook” that contains $500,000 of cash while fishing off the shore around New
Orleans. The US Customs and the DEA denied knowledge of the cash, so Sophi keeps it.
I.
Sophi will not recognize any gross income if the chest contained jewels valued at $500,000,
rather than cash at the time of discovery.
II.
Recognition is necessary because this is a treasure trove and it is comprised of cash.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
23. Ellie, age 12, earns wages of $4,300 from her modeling. Since the fees are collected by Ellie’s father and used for
Ellie’s living expenses, her father intends to include it in his gross income.
Ellie received no cash so does not have to report any income.
The Assignment of Income Doctrine prohibits the father from recognizing the $4,300.
Even if Ellie desired to gift the $4,300 to her father, Ellie must recognize the income she
earned.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Only statement III is correct.
d.
Only statements II and III are correct.
e.
Statements I, II, and III are correct.
24. Meredith, age 14, earns wages of $2,100 from her modeling. Since the funds are collected by Meredith’s father and
used for some of Meredith’s living expenses, her father intends to include it in his gross income.
I.
The person that actually earns the income will recognize it, Meredith in this case.
II.
The Assignment of Income Doctrine prohibits the father from recognizing the $2,100.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
25. Hilda, age 11, earns wages of $2,700 from her modeling. Since the funds are collected by Hilda’s father and used for
Hilda’s living expenses, her father intends to include it in his gross income.
I.
The Assignment of Income Doctrine prohibits the father from recognizing the $2,700.
II.
Even if Hilda desired to gift the $2,700 to her father, Hilda must recognize the income she
earned.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
26. Ramsey Corporation allows an employee, Corrine, to use a company car for her vacation to San Diego.
Corrine will not need to recognize the value of the use of the car since it was not cash.
A “cash equivalent approach” is used to measure the amount of income that must be
recognized by Corrine.
The employer/employee relationship indicates that the receipt of the use of the car is a type
of compensation for services rendered.
Income recognition is not necessary in this case.
a.
Only statement I is correct.
b.
Only statement IV is correct.
c.
Only statements II and III are correct.
d.
Only statements I and IV are correct.
e.
Only statements II, III, and IV are correct.
c
27. Alexis Corporation allows an employee, Cynthia, to use a company car for her vacation to San Diego.
I.
Cynthia will not need to recognize the value of the use of the car since it was not cash.
II.
A “cash equivalent approach” is used to measure the amount of income that must be
recognized by Cynthia.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
28. National Corporation allows an employee, Phyllis, to use a company car for her vacation to San Diego.
I.
The employer/employee relationship indicates that the receipt of the use of the car is a type
of compensation for services rendered.
II.
Income recognition is not necessary in this case.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
a
29. James bought an annuity for $42,000 several years ago. The annuity will pay him $250 per month from age 66 until he
dies. During the current year, James turns 66 and received his first annuity payment. His life expectancy is 25 years.
I.
If James receives more than 260 payments, all payments received after those are totally
included in income.
II.
James should include $50 of each payment in adjusted gross income.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
30. Charles bought an annuity for $30,000 several years ago. The annuity will pay him $250 per month from age 62 until
he dies. During the current year, Charles turns 62 and receives his first annuity payment.
I.
If Charles dies after receiving 192 monthly payments, he must amend prior returns and
correct the income reported based on 192 monthly payments.
II.
If Charles receives more than 260 payments, the total of each payment received after the
260th payment is included from income.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
31. Penny, age 45, purchased an annuity contract that cost $45,000. The contract will pay Penny $600 per month for 10
years after she reaches age 62. During the current year, Penny turns 62 and receives 4 payments under the contract.
Penny’s taxable income from the annuity payments is:
a.
$900
b.
$1,500
c.
$1,708
d.
$2,250
e.
$2,400
a
32. Penelope purchased an annuity contract that cost $45,000. The contract will pay Penelope $600 per month for 10 years
after she reaches the age of 62. During the current year, Penelope turns 62 and receives 4 payments under the contract.
The amount Penelope may exclude from taxable income as a return of capital on this years payments is:
Chapter 3
a.
$692
b.
$900
c.
$1,500
d.
$2,250
e.
$2,400
c
33. The income tax treatment of payments from annuity contracts is based on the:
Capital Recovery Concept
Assignment of Income Doctrine
Annual Accounting Period Concept
Arm’s-Length Transaction Concept
a.
Only statement I is correct.
b.
Only statement IV is correct.
c.
Only statements II and III are correct.
d.
Only statements I and IV are correct.
e.
Only statements I and III are correct.
e
34. Ursula owns an annuity that pays her $850 per month until she dies. Which of the following income tax concepts
provides for the tax treatment of the annuity payments Ursula receives (and the treatment in the year of death)?
Administrative Convenience Concept
Annual Accounting Period Concept
Capital Recovery Concept
Constructive Receipt Doctrine
a.
Only statements I and II are correct.
b.
Only statements II and III are correct.
c.
Only statements I and IV are correct.
d.
Only statement IV is correct.
e.
Only statement II is correct.
35. Lidia, age 62, retires this year from her job as executive vice-president of Western Inc. She will receive a pension of
$3,000 per month from Rollerderby‘s qualified pension plan. Lidia contributed $100,000 to the plan. Her contributions
were never subject to tax. In addition, she will receive $1,600 per month from an annuity she purchased many years ago at
a cost of $96,000. The pension and the annuity will be paid until she dies. At the date of her retirement, her life
expectancy is 30 years. Which of the following statements regarding the taxability of the payments is/are correct?
Under the capital recovery concept, Lidia will not have to recognize any income from the
annuity payment until she has recovered her $96,000 investment.
Lidia will not have to recognize as income the portion of each pension plan payment that
is considered a return of her $100,000 contribution to the plan.
Lidia will not have to recognize as income the portion of each annuity payment that is a
return of her $96,000 investment.
Because none of the contributions were taxed, Lidia will be taxed on the entire $3,000
from the pension plan.
a.
Only statement I is correct.
Chapter 3
b.
Only statements II and III are correct.
c.
Only statement III is correct.
d.
Only statements III and IV are correct.
e.
Only statement IV is correct.
36. Martin purchased an annuity contract at the beginning of 2002 for $84,000. The contract specifies that he will receive
$2,000 per month for life. Martin receives his first payments on July 1, 2014, when he was 67 years old. Martin dies on
August 15, 2019 (the August payment was received prior to his death). What amount, if any, should be deducted on
Martin’s 2019 tax return as a result of failing to receive his expected return on the annuity contract?
a.
$54,400 can be claimed as a deduction on his final return.
b.
$59,200 can be claimed as a deduction on his final return.
c.
$1,600 can be claimed as a deduction on his final return.
d.
No deduction is reported because a decedent is not required to file a final return.
37. Leroy purchased an annuity from an insurance company for $42,000. He has been receiving $940 monthly from the
annuity. Leroy began receiving the payments when he was 72 years old and he has now received annuity payments for
13.33 years. How much of each subsequent $940 payment must Leroy include in his gross income?
The Capital Recovery Concept explains the result.
Leroy may exclude 100% of the annuity payments received.
Leroy must recognize 100% of the annuity payments received.
Leroy will continue to recognize the same amount that he recognized in all prior years.
a.
Only statement I is correct.
b.
Only statement III is correct.
c.
Only statement IV is correct.
d.
Only statements I and III are correct.
e.
Only statements I and IV are correct.
38. Jerry purchased an annuity contract at the beginning of 2003 for $144,000. The contract specified that he and his wife
would receive $1,000 per month for life. Jerry receives his first payment on February 1, 2015 when he is 59 years old and
his wife is 56 years old. What amount of gross income should Jerry and his wife report on their 2015 income tax return
from this annuity contract?
a.
$-0-
b.
$4,400
c.
$6,600
d.
$11,000
c
39. Jennifer owns 60% of the stock in Heath Corporation. During the current year, Heath Corporation has taxable income
of $80,000 and pays dividends of $30,000. Which of the following statements about Jennifer’s income from Heath
Corporation is/are correct?
I.
If Heath Corporation is an S corporation, Jennifer must recognize $48,000 of income.
II.
If Heath Corporation is a corporation, Jennifer must recognize $18,000 of income.
a.
Only statement I is correct.
Chapter 3
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
40. Roberta invests $16,000 for a 10% interest in Bowie Partnership. In the first year of operations, Bowie reports net
income from operations of $80,000 and distributes $6,000 cash to Roberta. How much gross income must Roberta
recognize from her investment in Bowie?
a.
$2,000
b.
$6,000
c.
$8,000
d.
$80,000
c
41. Darnel owns 10% of the stock in Allison Company. During the current year, Allison has operating income of
$200,000 and distributes $80,000 to its owners.
I.
If Allison is a corporation, Darnel has $8,000 of income from Allison.
II.
If Allison is a partnership, Darnel has $20,000 of income from Allison.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
42. Which of the following statements concerning prizes and awards is/are correct?
Most all prizes and awards are exempt from taxation.
Employee awards of tangible, personal property for length of service are at least partially
excludable.
Any prize or award received can be excluded if it is given to a governmental or charitable
organization.
Employee awards for safety achievements are always excluded from income.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Only statements II and III are correct.
d.
Only statements I and IV are correct.
43. Nora, a single individual age 60, receives a gold watch worth $700 during her retirement luncheon, based upon her
long tenure with the company. How much of the award must Nora recognize in her gross income for the current year?
a.
$- 0 –
b.
$300
c.
$400
d.
$500
e.
$700
44. Teresa won $9,000 playing the Illinois lottery. Which of the following statements is/are correct?
Teresa must include the $9,000 in gross income.
The All-inclusive Income Concept applies to this situation.
Legislative Grace allows Teresa to exclude lottery winnings from recognition.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Only statement III is correct.
d.
Only statements I and II are correct.
e.
Statements I, II, and III are correct.
45. Gary won the Nobel Prize in Economics. He receives $1.2 million from the Royal Academy of Sciences in Stockholm.
Does he have taxable income from this award?
I.
If he keeps the prize money, he must include the award in his gross income.
II.
If he tells the Academy to contribute the award to a charitable organization, the amount
of the award is excludable from gross income.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
46. Paul won the Nobel Prize for Literature. He is awarded $1,000,000. His tax situation is
In general, the award must be included in gross income.
The award may be excluded if he gives it to a qualified charity.
The award may be excluded if he gives it to the U.S. Government.
Awards for literary achievement are not taxable.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Only statements I, II, and III are correct.
d.
Only statement IV is correct.
e.
Only statements I, II, and IV are correct.
c
47. Janelle receives a sterling silver tea set valued at $500 from her employer during her retirement dinner for her long
years of service. The employer has a tradition of giving awards to some retiring employees, but has no qualified plan.
I.
$400 is excludable from Janelle’s Gross Income.
II.
The $500 is excludable even if her employer only gives awards to its top executives.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
a
48. Which of the following statements is/are correct?
Chapter 3
Maria receives a necklace worth $300 from her employer in recognition of her production
unit’s safety record at the company’s annual meeting. Maria is not taxed on the $300.
Reggie opens a savings account at Mid Financial Savings and Loan. For opening the
account he receives a microwave worth $200. On December 31, his account is credited for
$300 of interest income. Reggie must report $500 of income.
Manu receives a salary of $80,000 as CEO of Camp’s Cooking Crockery. Manu owns 60%
of Camp’s, which is organized as an S corporation. Camp’s taxable income for the current
year is $300,000 and Camp’s pays $100,000 of dividends. Manu must recognize $360,000
of income.
a.
Statements I, II, and III are correct.
b.
Only statements I, and II are correct.
c.
Only statements II and III are correct
d.
No statement is correct.
49. Ona is a retired schoolteacher who receives a pension of $800 per month (Ona made no payments into the pension
plan) and $2,000 of Social Security benefits per month. Ona’s adjusted gross income is:
a.
$9,600
b.
$13,900
c.
$21,900
d.
$24,000
e.
$33,600
a
50. Rae is a retired corporate executive. He and his wife, Pat, receive pensions totaling $82,000 and $8,000 of Social
Security benefits during the current year. Rae and Pat’s adjusted gross income is
a.
$82,000
b.
$86,000
c.
$87,400
d.
$88,800
e.
$90,000
51. Binney is a retired auto mechanic. He and his wife, Jennie, receive taxable pensions totaling $35,000, $8,000 of tax-
exempt interest income and $6,000 of Social Security benefits during the current year. Assuming that they had no other
items of income or deductions for adjusted gross income, Binney and Jennie’s adjusted gross income is:
a.
$35,000
b.
$36,700
c.
$38,000
d.
$39,700
e.
$40,100
52. Lyle and Louise are retired living on income from their investments and Social Security benefits. During the current
year, they receive the following:
Cash dividends on stock investments
$28,000
Interest on municipal bonds
5,000
Chapter 3
Social Security benefits
18,000
Lyle and Louise’s adjusted gross income is:
a.
$28,000
b.
$33,000
c.
$37,000
d.
$48,000
e.
$41,300
c
53. Marvin and Simone are a retired couple living on income from their investments and Social Security benefits. During
the current year, they receive the following:
Consulting fee from Burton Industries
$35,000
Interest on municipal bonds
7,000
Social Security benefits
20,000
Marvin and Simone’s adjusted gross income is:
a.
$45,000
b.
$47,800
c.
$52,000
d.
$55,000
e.
$61,000
54. Hector and Nicole are retired. During the current year, they receive $11,000 from a qualified pension plan, $3,000 of
dividends on common stock holdings, $6,000 of tax-exempt interest, and $10,000 of Social Security benefits. Hector and
Nicole’s adjusted gross income is:
a.
$14,000
b.
$19,000
c.
$24,000
d.
$30,000
a
55. Marvin and Stacy are retired. During the current year, they receive $10,000 in Social Security benefits. They have
$45,000 of other taxable gross income and receive $23,000 of municipal bond interest. The taxable portion of the $10,000
Social Security payment is:
a.
$-0-
b.
$5,000
c.
$8,500
d.
$10,000
c
56. Nellie, a single individual age 77, receives Social Security benefits of $7,000 during the current year. Her only other
income consists of $5,000 of interest from bank CDs and $1,000 of tax exempt interest distributed from a trust fund.
Nellie’s gross income is:
a.
$- 0 –
b.
$5,000
c.
$8,500
d.
$12,000
Chapter 3
e.
$13,000
57. In what circumstances would some portion of the Social Security benefits received by a single taxpayer be subject to
taxation? Assume that all sources of income are listed.
a.
Taxpayer’s only income consists of $24,000 in Social Security benefits.
b.
Taxpayer receives $12,000 in Social Security benefits, dividend income of $6,000, and municipal bond
interest of $3,000.
c.
Taxpayer receives $10,000 in Social Security benefits, qualified pension plan benefits of $13,000, and
municipal bond interest of $8,000.
d.
Taxpayer receives $20,000 in Social Security benefits and qualified pension plan benefits of $14,000.
e.
One-half of Social Security benefits are always taxable
c
58. Todd and Fiona are negotiating a divorce settlement. Todd has offered to pay Fiona $12,000 each year for 10 years,
but payments cease upon Fiona’s death. What are the tax implications of this proposition?
Fiona must recognize Gross Income when the money is received.
Todd has a deduction for Adjusted Gross Income in the year of payment.
Since the payments are in cash and there is no obligation to pay more after Fiona’s death,
the payments are classified as alimony.
If the payments qualify as child support, Fiona recognizes no gross income and Todd has
no deduction from Adjusted Gross Income.
a.
Only statement I is correct.
b.
Only statement IV is correct.
c.
Only statements I and II are correct.
d.
Only statements I, II, and III are correct.
e.
Statements I, II, III, and IV are correct.
e
59. Frank and Lilly are negotiating a divorce settlement. Frank has offered to pay Lilly $12,000 each year for 10 years, but
payments cease upon Lilly’s death. What are the tax implications of this proposition?
I.
Lilly must recognize Gross Income when the money is received.
II.
Frank has a deduction for Adjusted Gross Income in the year of payment.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
60. Waldo and Fern are negotiating a divorce settlement. Waldo has offered to pay Fern $12,000 each year for a
guaranteed 10 years. What are the tax implications of this proposition?
I.
Since the payments are periodic and in cash, the payments qualify as alimony.
II.
If the payments qualify as child support, Fern recognizes gross income and Waldo has a
deduction from Adjusted Gross Income.
a.
Only statement I is correct.
b.
Only statement II is correct.
Chapter 3
c.
Both statements are correct.
d.
Neither statement is correct.
61. Ralph and Renee are negotiating a divorce settlement. Renee has an option of taking a property settlement of $100,000
or alimony payments of $12,000 per year for 10 years. Without considering the time value of money, which of the
following statements is true?
I.
If Renee expects that she will be in the 25% marginal tax bracket, she should take the
property settlement of $100,000.
II.
If Renee expects that she will be in the 25% marginal tax bracket, she should take the
alimony of $12,000 per year for 10 years.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
a
62. As a result of their divorce this year, Carlos made the following payments to Michelle, his former wife:
•
He transferred the family car to Michelle. The car cost them $20,000 and was worth $10,000 at
the time that he gave it to Michelle.
•
Carlos paid Michelle 12 monthly cash payments of $1,000 each. These payments are to
continue as long as Michelle lives or until their son is age 19. When their son attains age 19,
the payments will be reduced to $600 a month.
•
On June 6, Carlos paid Michelle a single cash payment of $70,000 to help her settle in a new
home. Carlos kept the family home.
How much gross income should Michelle report as a result of the above transfers?
a.
$7,200
b.
$12,000
c.
$17,200
d.
$87,200
e.
$92,000
a
63. Glenn and Vera divorce during the current year. Per their divorce agreement, Glenn receives their former personal
residence valued at $180,000 with a basis of $100,000. Also, Glenn will pay Vera $5,000 annually for eight years. If Vera
dies before the end of the eight years, the balance of the payments is to be paid to Vera’s estate in a lump sum. The couple
has not lived together for the past two years.
a.
Glenn can deduct $5,000 annually for alimony paid to Vera.
b.
Vera can deduct $40,000 (1/2 of the unrealized gain on the house).
c.
Vera does not recognize any income from the property and/or cash transactions.
d.
Vera must recognize $40,000 as a gain on the disposition of her interest in the house.
e.
Vera must recognize all the cash received as alimony income.
c
64. Al and Peggy divorce in the current year. As part of their divorce agreement, Peggy is to pay Al $70,000 for his share
of their home (the home’s fair market value is $140,000). Also, Peggy agrees to pay Al $1,000 monthly. The payment
represents the financial support for their 15-year-old son, Bud. It will cease upon Bud’s 23rd birthday or college
Chapter 3
graduation-whichever comes first. Which of the following explain(s) the tax effects of these events?
I.
Peggy can deduct $12,000 annually for the monthly payments made this year.
II.
Al does not recognize the $1,000 monthly payments as income.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
65. The intent of the alimony recapture rules is to
a.
Prevent the payee from having a large tax liability when there is not an adequate wherewithal to pay.
b.
Prevent former spouses from skipping out of their obligations to pay the other spouse.
c.
Reclassify property settlements as capital gains, rather than ordinary income.
d.
Prevent child support from being disguised as alimony.
e.
Prevent tax deductions for property settlements.
e
66. Sonya and Butch divorce during the current year. Their divorce agreement requires Sonya to pay Butch alimony of
$2,500 monthly. When their son, Bubba, attains the earliest of either the age 23 or graduates from college, the payments
will cease.
Butch must recognize gross income of $2,500 monthly.
Sonya may deduct $2,500 monthly from her gross income.
Butch will not recognize any gross income due to the payments.
a.
Only statements I and II are correct.
b.
Only statement I is correct.
c.
Only statement II is correct.
d.
Only statement III is correct.
67. How much gross income does Faith have from the following items of economic income?
•
Received cash gift of $6,000 from parents.
•
Received $12,000 in alimony payments from former spouse.
•
Received $18,000 in child support payments from former spouse.
•
Won $6,000 in a slot machine in Las Vegas.
•
Faith’s vacation home on Lake Tahoe increased in value by $15,000.
•
Collected $14,000 in unemployment benefits.
a.
$18,000
b.
$30,000
c.
$32,000
d.
$38,000
e.
$50,000
c
68. How much gross income does Ron have from the following items of economic income?
•
Received cash gift of $5,000 from parents.
•
Received $12,000 in alimony payments and $6,000 in child support from former spouse.
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•
Won $4,000 in Indiana lottery scratch off game.
•
Investment in IBM stock increased in value by $15,000.
•
Collected $12,000 in unemployment benefits.
a.
$16,000
b.
$28,000
c.
$33,000
d.
$34,000
e.
$54,000
69. One type of imputed income that always escapes taxation is
a.
Bargain purchases by employees.
b.
Value of growing one’s own vegetables for personal consumption.
c.
Payment of personal expenses by a corporation in which stock is owned.
d.
Interest free loan from parents.
70. Under the imputed interest rules, gift loans between a daughter (lender) and her mother (borrower) may result in
No imputed interest income recognized by the mother.
No imputed interest deduction by the daughter.
Imputed interest income recognized by the daughter.
Deduction allowed for imputed interest expense by the mother.
a.
Only statements I, II, and III are correct.
b.
Only statements I and IV are correct.
c.
Only statements I and II are correct.
d.
Only statement III is correct.
e.
Only statements III and IV are correct.
e
71. Which of the following never generate taxable income?
Interest free loan from family member.
Interest free loan from employer.
Interest free loan under $10,000.
Interest free loan over $100,000.
a.
Only statement I is correct.
b.
Only statements I and III are correct.
c.
Only statements I and II and III are correct.
d.
Only statement III is correct.
e.
Only statements II and III are correct.
72. Which of the following always generate taxable income?
Interest free loan over $10,000 from family member.
Interest free loan over $10,000 from employer.
Interest free loan under $10,000.
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Interest free loan over $100,000.
a.
Only statement I, II and IV are correct.
b.
Only statements II and III are correct.
c.
Only statements I and IV are correct.
d.
Only statement IV is correct.
e.
Only statements II and IV are correct.
e
73. On January 1, Sandi borrows $40,000 from G&H Accounting firm, her employer, to pay-off charge accounts and
other personal loans. Sandi must repay the $40,000 loan at the end of 5 years. Because Sandi has been loyal to her job,
G&H is not charging Sandi interest on the $40,000 loan. The applicable federal interest rate is 6%. If Sandi has total net
investment income for the current year of $200:
I.
Sandi has compensation income of $2,400.
II.
Sandi has a nontaxable gift from her employer of $2,400.
III.
G&H is allowed a deduction for $2,400 of compensation paid to Sandi.
IV.
There are no tax effects because Sandi’s net investment income is less than $1,000.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Only statements I and III are correct.
d.
Only statements II and IV are correct.
e.
Only statements II and III are correct.
c
74. Nathan loans $50,000 to Ramona on January 1 of the current year. The terms of the loan require Ramona to pay
Nathan $5,000 per year on December 31 each year for the next 10 years (i.e., no interest is charged on the loan).
Assuming that the applicable federal rate is 6% and Ramona has total investment income of $1,200 during the current
year:
I.
If Ramona is Nathan’s sister, Nathan must recognize $3,000 of interest income from the loan.
II.
If Ramona is an employee of Nathan’s, Nathan must recognize interest income of $3,000 and
receives a deduction for compensation paid of $3,000.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
75. Art has worked for Denver’s Diamond Dealers (DDD) for ten years. During the current year, Art marries and moves
from his downtown apartment to a house in the suburbs. Before he was married, Art always rode the bus to work. Because
there is no bus service to his new home, Art needs to purchase a car. Wayne, the owner of DDD gives Art $17,000 to
purchase a used car. Which of the following statements concerning the $17,000 payment is/are correct?
I.
If DDD does not require Art to repay the $17,000, Art has $17,000 of compensation income.
II.
If DDD requires Art to repay the $17,000, Art has no compensation income from the receipt
of the $17,000.
a.
Only statement I is correct.
b.
Only statement II is correct.
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c.
Both statements are correct.
d.
Neither statement is correct.
c
76. Imputed interest rules and policies include which of the following?
Gift loans have no income tax effect to the lender.
Any loan of $10,000 or less is exempted from imputed interest rules.
On gift loans of $100,000 or less, the imputed interest on the loan cannot exceed the
borrower’s net investment income for the year.
With a loan to a shareholder, a corporation can deduct the imputed payment.
a.
Only statement I is correct.
b.
Only statements I and IV are correct.
c.
Only statement II is correct.
d.
Only statements II, and III are correct.
e.
Only statements II, III, and IV are correct.
77. Karl is an employee of Cars-R-Us. As part of their employment agreement, Cars-R-Us loans Karl $1,000,000 interest-
free to assist in the purchase of a car dealership. Assume the federal rate of interest is 8%. What is the tax treatment of the
loan?
The arrangement has no tax consequences to Karl.
Cars-R-Us is deemed to have paid Karl compensation of $80,000.
Karl is deemed to have paid Cars-R-Us $80,000 of interest.
Cars-R-Us’ net income tax effect is zero due to this arrangement.
a.
Only statement I is correct.
b.
Only statements I, II, and IV are correct.
c.
Only statement III is correct.
d.
Only statements I, II, and III are correct.
e.
Only statements II, III, and IV are correct.
e
78. Which of the following interest-free loans is subject to the imputed interest rules (i.e., interest must be imputed on the
loan)?
Marilyn loans $24,000 to her grandmother and she uses the money to pay personal
expenses and take a vacation. Her grandmother’s sole income is from Social Security.
Pineview Corporation loans $20,000 to Catherine, an employee. Catherine uses the
proceeds as a down payment on a house. Catherine’s net investment income for the year is
$300.
Scott loans $65,000 to his son. His son uses the money to open a new business. During the
current year, the business shows a loss and his son has no other sources of income.
Alaric Corporation loans $27,000 to its principal shareholder. The shareholder uses the
funds to buy additional shares of stock in Alaric. The shareholder is deemed to receive
$8,500 of dividends from Alaric during the year.
a.
Only statement II is correct.
b.
Only statements I and III are correct.
c.
Only statements II and IV are correct.
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d.
Only statements I and IV are correct.
e.
Only statements II and III are correct.
c
79. Which of the following interest-free loans is subject to the imputed interest rules?
I.
Lena needed $5,000 to pay off some gambling debts. Her employer loans her the $5,000.
II.
Sherry loans her son $130,000 to purchase a motor home to use in his landscaping business.
Her son has no investment income for the year.
a.
Only loan I.
b.
Only loan II.
c.
Both loans.
d.
Neither loan.
80. Which of the following interest-free loans is subject to the imputed interest rules (i.e., interest must be imputed on the
loan)?
I.
Benito loans $250,000 to his son. His son uses the money to open a new business. During
the current year, the business shows a loss and his son has no other sources of income.
II.
Bisbane Corporation loans $8,000 to its principal shareholder. The shareholder uses the
funds to buy additional shares of stock in Arcane. The shareholder is deemed to receive
$4,000 of dividends from Brisbane during the year.
a.
Only loan I.
b.
Only loan II.
c.
Both loans.
d.
Neither loan.
a
81. Roberto is a furniture salesman for Gerald’s Furniture Mart. Roberto purchases a bedroom suite from Gerald’s for
$8,000. The sticker price is $11,000. Gerald’s policy is to “discount” all customer purchases for up to $1,000 off of the
sticker price for purchases over $10,000. What is the tax treatment of Roberto’s furniture purchase?
Roberto must include $3,000 in his gross income.
Gerald’s Furniture Mart can deduct $2,000 as compensation expense in addition to
properly accounting for the sale of the furniture.
Roberto does not need to account for the furniture purchase since it is for his personal use.
Roberto has imputed income because of the nature of the furniture purchase.
a.
Only statement I is correct.
b.
Only statement III is correct.
c.
Only statements I and IV are correct.
d.
Only statement IV is correct.
e.
Only statements II, and IV are correct.
e
82. Jerry is a furniture salesman for Ashland‘s Furniture Mart. Jerry purchases a bedroom suite from Ashland’s for
$10,000. The sticker price is $14,000. Ashland’s policy is to “discount” all customer purchases for up to $2,000 off of the
sticker price for purchases over $10,000. What is the tax treatment of Jerry’s furniture purchase?
I.
Jerry must include $4,000 in his gross income.
Chapter 3
II.
Ashland’s Furniture Mart can deduct $2,000 as compensation expense in addition to properly
accounting for the sale of the furniture.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
83. Stephen is a furniture salesman for Foster’s Furniture Mart. Stephen purchases a bedroom suite from Foster’s for
$8,000. The sticker price is $11,000. Foster’s policy is to “discount” all customer purchases for up to $1,000 off of the
sticker price for purchases over $10,000. What is the tax treatment of Stephen’s furniture purchase?
I.
Stephen does not need to account for the furniture purchase since it is for his personal use.
II.
Stephen has imputed income because of the nature of the furniture purchase.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
84. Patti sells a painting that has a fair market value of $9,000 to James for $6,000. Which of the following statements
about the tax effect of the sale is/are correct?
If James is an employee of Patti’s, no income is recognized from the sale.
If James is Patti’s brother, James does not recognize any income from the sale.
If Patti is an art dealer and she sold the painting to James because she needed cash quickly,
James does not recognize any income from the sale.
If James owns 60% of Patti’s company, James does not recognize any income from the
sale.
a.
Only statement II is correct.
b.
Only statement III is correct.
c.
Only statements II, and III are correct.
d.
Only statements II, III, and IV are correct.
e.
Statements I, II, III, and IV are correct.
c
85. Elise sells a painting that has a fair market value of $9,000 to Jon for $6,000. Which of the following statements about
the tax effect of the sale is/are correct?
I.
If Jon is an employee of Elise’s, no income is recognized from the sale.
II.
If Jon is Elise’s brother, Jon does not recognize any income from the sale.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
86. Elizabeth sells a painting that has a fair market value of $9,000 to Jonathan for $6,000. Which of the following