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throw it away. However, she noticed what appeared to be another painting behind the one she
bought. Curious, she took the painting to a friend who is a local art expert. The friend thought
the second painting was a lost “Monet” and could be worth millions. Angie sends the painting
to a museum in Boston, which confirms that the painting is indeed a lost “Monet.” Similar
paintings have been selling for $650,000 to $800,000, although the art market is in a down
cycle. Angie decides to wait until the art market picks up a bit to sell the painting.
$14,000 ($50,000 – $36,000) gain realized. [($16,000 ÷ $50,000) × $14,000] = $4,480 gain
Randy becomes owner of the bond on September 30. The receipt of the bond is excluded from
gross income because it is a gift. However, Kenneth must recognize the interest income earned
interest (September 30 to December 31).
c.
David must recognize the $550 in the year the check was written. The funds were available to
d.
Angie has discovered a “treasure trove.” However, no realization has occurred. Angie has no
Angie sells or exchanges the artwork.
128. Explain why the taxpayer in each of the following situations either does or does not have taxable income and
determine the amount, if any, that the taxpayer would have to recognize.
a.
Rafael works as a salesman of Dependable Cars Inc. Because Rafael is the year’s top
salesman, Dependable Cars allows Rafael to purchase a car for $30,000, which normally
sells for $35,000 (Dependable Car’s cost was $28,000).
b.
Janine’s brother Barry is laid off from his job for the first half of the year. Because Barry
is having trouble paying all of his bills, Janine tells Barry that she will help him out and
pay the property taxes on Barry’s house. The property taxes amount to $1,000.
c.
Thomas works as a production manager for Healthy Body, Inc. Because Thomas’s unit
had not had a work related accident for 2 years, Healthy Body gives Thomas a weight
machine that was worth $500.
d.
Emmett was out for his daily walk when he spots an old shirt on the side of the road.
Upon inspection, he determines it to be an old baseball uniform, which is in good enough
condition that he takes it home and washes it. At a party two months later, Mark, a
baseball memorabilia collector, tells him that it might be worth something. Emmett takes
the shirt down to the local collector’s shop where he learns that the shirt was once worn
by Willie Mays and is worth at least $7,000.
e.
Helen invests $10,000 for a 25% interest in Lockport Landscaping, an S corporation, on
January 1, 2015. During 2015, Lockport pays Helen $45,000 in wages for her services as
the general manager and $2,000 in cash dividends on her stock. Lockport reports a 2015
net income of $80,000.
f.
Amber wins $10,000 in the state lottery from a ticket given to her by her cousin, Beverly.
129. Explain why the taxpayer in each of the following situations either does or does not have taxable income and
determine the amount, if any, that the taxpayer would have to recognize.
a.
On December 1, 2015, Tomlin, a cash basis taxpayer, bills a customer $5,000 for services
rendered throughout 2015. The customer comes to Tomlin’s office on December 30, 2015,
and offers to pay him the $5,000 amount owed. Tomlin suggests that the customer mail the
check to him so he could see how quickly the post office could get the check to him through
the mail. The post office delivers the check to Tomlin on January 10, 2016. Tomlin promptly
deposits the check in the bank.
b.
Patty, age 65, will retire this year. Twenty years ago she purchased a retirement annuity
contract at a cost of $6,000. Under the terms of the contract, Patty is to receive $150 per
month for 10 years after reaching age 65. During the current year, Patty receives $1,200 (8
payments).
c.
Bud is an accountant for Big Oil Company. In his spare time, Bud collects unique beer cans
and bottles. During a party at his house, one of his friends tells him that his can of Billy Beer
is a hot item in the professional collector’s market. Bud investigates and instead of selling the
Billy Beer, he trades the can of Billy Beer for a bottle of Leinenkugles beer.
d.
Rosemary is awarded the “Outstanding Teaching Award” at DePauw University. She
receives a plaque and $3,500. She assigns the $3,500 to DePauw to establish a scholarship
for economics majors.
Patty must include $800 of the annuity payments in her gross income. Using the annuity
are not allowed to purchase cars at similar discounts.
b.
Barry does not have taxable income from the payment of his property taxes by Janine.
d.
Emmett’s wealth increased due to a “treasure trove.” However, no realization has
recognition will occur when Emmett sells or exchanges the shirt.
Helen has gross income of $65,000. Because Lockport is a conduit entity, Helen must
Amber’s gross income is $10,000. The gift of the ticket merely transfers ownership of the
inclusive income concept.
130. Determine the amount of gross income the taxpayer must report in each of the following situations. Explain why the
amount is taxable and how you determined the taxable amount.
a.
Marlon purchased an annuity costing $13,000 that will pay him $300 per month for life
upon reaching age 65. In 2015, when his life expectancy is 14 years, Marlon turns 65 and
begins receiving the annuity payments. In 2015, Marlon receives $1,800 (6 payments) from
the annuity.
b.
Fargo Systems Corporation, an accrual basis taxpayer, leases computer time on its
mainframe computer. In November 2015, Fargo enters into a two-year lease with Bismarck
Processing, Inc. The lease agreement requires Bismarck to pay a $4,800 fixed fee when the
lease is signed and $100 per hour of mainframe use, paid on a monthly basis. Fargo receives
the $4,800 payment on November 1, 2015. Bismarck pays Fargo $800 on December 15,
2015 for November computer use and $1,200 on January 18, 2016 for December computer
use.
c.
Maria, a single taxpayer, is retired. During the current year she receives $19,000 from her
employer’s qualified pension plan, $1,000 in interest on a savings account, $30,000 in
interest on tax-exempt municipal bonds, and $10,000 in Social Security benefits.
d.
Stuart works for Prairie Surveyors of Kansas. During the current year, Prairie Surveyors
replaces all of its computer equipment. Stuart makes a deal with his boss to purchase one of
the old computers for $200. Prairie Surveyors received a $1,000 trade-in allowance on the
other computers it replaced.
exclusion formula, she excludes $50 of each payment as a return of investment, leaving $100
Excluded Amount = $6,000 / ( ) = $50 Taxable amount = $150 – $50 = $100 × 8 = $800
c.
Bud has income from the exchange of the beers. He has realized the value of the Billy Beer in
Leinenkugles beer over his tax cost of the Billy Beer.
d.
Rosemary is not taxed on the award because it was given in recognition of academic
assigned the proceeds to a charitable organization.
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131. Determine the amount of gross income the taxpayer must report in each of the following situations. Explain why the
amount is taxable and how you determined the taxable amount.
a.
National Corporation receives a $12,000 bill for legal fees from its attorney in December.
National paid the bill promptly and deducted the $12,000 as a legal expense for its year
ending December 31. During the audit of its financial statements, the auditor determines
that the attorney had double billed the corporation for $3,000 of expenses. National sent
a copy of the auditor’s findings in March. The attorney agrees with the auditor and sends
National a check for $3,000 in April.
b.
Greta spends a week in Las Vegas. While cashing in some of her chips at the cashier’s
window, she looks down and sees a $1,000 bill lying crumpled on the floor. She picks up
the bill and puts it in her pocket.
c.
Akron Living, Inc., an accrual basis corporation, owns an apartment building. On
November 1, it rents an apartment for $400 per month. Per the terms of the rental
agreement, the tenant pays the corporation $1,100 on November. The $1,100 consists of
the first and last months rent and a $300 cleaning deposit. The cleaning deposit will be
rused at the end of the lease and any amount not used for cleaning will be returned to the
tenant. Very little is usually returned.
d.
Anthony is an employee of the Channel Company. Channel Company institutes a
computer upgrade and offers its old computers for sale for $700. Anthony offers Channel
$500 for one of the computers. Because they have not been selling well, Channel accepts
Anthony’s offer and sells him a computer for $500.
e.
James owns Argyle Co. as a sole proprietorship. In November, James pays a $600 bill for
supplies and deducts it on his tax return. The following February, the supplier sends
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James a check for $120. A letter accompanying the check indicated that the supplier had
overcharged Argyle Co. and the check was to adjust for the overcharge.
income. There is no legislative grace that permits exclusion of cash treasure troves.
deposit is not taxable because Akron Living does not have a claim of right to the deposit
annual accounting period concept does not allow Argyle Co. to go back and amend the
132. Victoria is an employee of The Bellamy Corporation. During a recent business trip, one of Victoria’s connecting
flights was overbooked. Because Victoria did not have a business meeting until the next day, she volunteered to take the
next available flight. The airline gave Victoria a $20 meal ticket and a coupon worth $100 off any future flight on the
airline for giving up her seat on the overbooked flight. Has Victoria realized income from the receipt of the meal ticket
and the coupon? Explain in terms of the income tax concepts.
133. Twenty years ago Pricilla purchased an annuity costing $19,500 that will pay her $250 per month from age 65 until
she dies. Polly is an employee of Evergreen Corporation. During her employment with Evergreen, Polly has paid a total of
$20,000 into Evergreen’s qualified employee pension plan. Under the plan, Polly is to receive $250 per year from age 65
until she dies. Pricilla and Polly turn 65 during the current year and retire. Each of them has a life expectancy of 12 years
from the date of retirement. Discuss the differences in the treatment of the $250 payments each of them receives.
134. In 2004, the Force Partnership purchased an apartment building for $600,000 and paid an additional $10,000 in
acquisition fees. Tthe partnership properly claimed $130,000 in depreciation on the building. In 2015, Force allows the
building to be foreclosed by the bank for $490,000, the amount of the outstanding loan principal. What is the realized gain
or loss, if any, for the partnership resulting from the foreclosure?
135. Belina and Harry form the B&H Partnership in 2015. Belina contributes $15,000 for a 25% interest in the
partnership. Harry contributes a building worth $45,000 for a 75% interest in the partnership. During 2015, B&H reports
an income of $12,000 from operations. Belina withdraws $6,000 and Harry withdraws $12,000 from the partnership. How
much gross income will Belina and Harry report from their investment in B&H and what are their bases in the partnership
at the end of 2015?
136. Amanda, who is single, owns 40% of the Sherwood Partnership. During the current year, Sherwood has the
following results:
Sales
$380,000
Long-term capital gain
20,000
Operating expenses
280,000
a.
Amanda withdraws $30,000 from the partnership. In addition, Amanda has a $30,000
long-term capital loss from the sale of an investment. What is Amanda’s gross income
from this information? Explain and show your calculations.
b.
Assume that in the next year, Sherwood Publishing has $80,000 of ordinary income,
Amanda has a $24,000 short-term capital gain and taxable income from other sources
of $20,000. What is her adjusted gross income? Explain and show your calculations.
other taxable income and her $32,000
Taxable income from other sources
Sherwood Publishing income (40%)
Capital gains netting:
Long-term capital loss
137. Barrett is a real estate broker. He actively advertises his own and his clients’ real estate for sale. He had the following
transactions for one segment of his business:
1/15/06
Purchased property A for $50,000
2/15/10
Paid $10,000 to put up fencing on property A
6/20/10
Purchased property C for $18,000
1/15/15
Sold property C for $23,000
7/30/15
Sold property A for $95,000
How should Barrett account for the sales in 2015?
(they are inventory items). Sales of inventory are excluded from capital asset classification.
138. On December 24 of the current year, Louise is given a certificate by her employer entitling her to $1,500 worth of
lodging at a Vail Village resort. The certificate states that it represents a “thank you” for graciously taking care of some
client problems that were beyond the scope of normal business activities. The certificate is nontransferable. How much
gross income must Louise recognize in the current year due to the certificate? Explain.
139. Arnold is the President of Conrad Corporation. Arnold owns 30% of Conrad, which is organized as an S corporation.
Arnold’s salary is $100,000. Conrad reports the following for the current year:
Sales
$4,000,000
Cost of goods sold
(1,700,000)
Operating expenses
(1,200,000)
Salaries (includes Arnold’s salary)
(600,000)
Capital loss
(200,000)
Net income
$300,000
Conrad Corporation pays $400,000 of dividends. Explain the effect of the above information on Arnold’s taxable income.
140. Sarah is single and retires in 2015. During 2015, Sarah’s income consists of a $24,000 taxable pension and $10,000 in
Social Security benefits.
a.
How much of the Social Security benefits must be included in Sarah’s 2015 gross income?
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b.
If Sarah also receives $7,000 in tax-exempt interest in 2015, how much of the Social
Security benefits must be included in her 2015 gross income?
or
The lesser of:
1.
85% × $10,000 = $8,500
or
2.
The sum of:
85% × ($36,000 – $34,000) =
b.
The smaller of:
4,500
141. Melissa is currently working with her divorce attorney on her impending divorce from her husband David. She
recently discovered that she is pregnant with David’s child. Melissa intends to keep and raise the child. David’s attorney
has submitted a proposal that David pay Melissa alimony of $1,500 per month. The proposed alimony contract satisfies
the IRS tests for alimony. As a tax planner, what advice do you have for Melissa? Is there a way to structure the payments
to minimize Melissa’s income taxes?
142. Stephanie and Matt are married with 2 dependent children. During 2015, they have total gross income of $140,000.
Their allowable deductions for adjusted gross income total $6,000 and they have $6,000 of allowable itemized deductions.
Compute Stephanie and Matt’s 2015 taxable income and 2015 income tax liability.
a.
Assume that in addition to the above information, Stephanie sold some land that she had
held as an investment at a gain of $5,000. What is the effect of the gain on their taxable
income and income tax liability? You do not need to recalculate, just explain the general
effect of the sale of the land.
b.
Assume the same facts as in part (a) and that Matt also sold some stock he purchased
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several years ago at a $12,000 loss. What is the effect of the gain on the land and the loss
on the stock on their taxable income? Explain.
Gross income
Deductions for AGI
Deductions from AGI (Standard deduction)
Personal exemptions (4 × $4,000)
Taxable income
25%) if the gain is short-term or by $750 ($5,000 × 15%) if it is long-term.
143. On January 1 of the current year, Beverly borrows $100,000 from her employer, Happy Hills Nursing Home. Beverly
uses this loan to pay off credit cards and consumer loans. Happy Hills considers Beverly to be a loyal employee, and
allows her up to five years to repay the loan. Beverly is not a shareholder or officer in the Happy Hills. Happy Hills does
not charge any interest on the loan. Both Happy Hills and Beverly are on a December 31 fiscal year end. What is the
income tax issue for Happy Hills? You do not need to do any calculations.
Imputed interest rules
Below-market rate loans
Employment-related loans
Arm’s-length transaction concept
compensation expense for Happy Hills.
144. Cathy, an attorney, bills a client $12,000 for services rendered in November 2015. The client is having cash flow
problems and Cathy accepts 1,000 shares of Petrol Corporation common stock in full satisfaction of the account on July 5,
2016. On July 5, 2016, the Petrol stock is selling for $10 per share. Cathy sells the Petrol stock on August 10, 2016, for
$11 per share. What is the effect of the transactions on Cathy’s 2016 taxable income if
a.
Cathy is a cash basis taxpayer?
b.
Cathy is an accrual basis taxpayer?
short-term capital gain of $1,000 ($11,000 – $10,000) from the sale of the stock in 2016.
b.
Cathy will recognize $12,000 of income from services in 2015. When she accepts full
Chapter 3
Match each statement with the correct term below.
a.
The category of income that includes interest, dividends, and rents.
b.
Income from wages, salaries, and trade or businesses.
c.
Interest income resulting from making an interest-free gift loan of $200,000.
d.
A taxable amount received from a state plan to provide a substitute for an employee’s earned income.
e.
A series of equal payments received over equal time periods.
f.
A receipt of cash from a former spouse that is included in gross income.
g.
A payment received from a former spouse that is not included in gross income.
h.
A division of marital assets that does not result in any income recognition.
i.
A sale of property in which at least one payment is received in a tax year after the year of sale
j.
A method of accounting that must be used to recognize income from long-term construction contracts.
k.
A debt instrument that has the interest paid at maturity rather than throughout the life of the debt.
145. Alimony
146. Annuity
147. Child-support payment
148. Earned income
149. Imputed income
150. Installment sale
151. Original issue discount security
152. Percentage of completed contract method
153. Property settlement
154. Unearned income
155. Unemployment compensation
term capital gain of $1,000 from the sale of the stock in 2016.
Chapter 3