Chapter 4
89. Items that are excluded from gross income include all of the following with the exception of:
a.
gifts.
b.
inheritances.
c.
life insurance proceeds.
d.
municipal bond interest.
e.
U.S. Treasury Bills interest.
e
90. Norma is in the 33% marginal tax bracket. Because of her high tax rate, Norma would like to reinvest a $10,000, 6%,
certificate of deposit in a tax-exempt bond. What is the minimum rate of interest Norma would have to receive to make
the tax exempt-bond a more profitable investment?
a.
4.1%
b.
6.0%
c.
8.4%
d.
9.0%
a
91. Clark, a single taxpayer with expected taxable income of $190,000, needs your advice on an investment decision.
Clark wants to invest $10,000 in long-term bonds. Clark can obtain a 6% return by investing in 10-year Ford Motors’
bonds. What is the minimum interest rate that Clark should demand from an investment in State of Tennessee bonds of
identical risk and duration?
a.
b.
c.
d.
a
92. The information that follows applies to the current year for Aaron and Janelle, a married couple.
•
Aaron is employed as a shoe salesman; his compensation is $75,000.
•
Janelle is employed by the state of Indiana; her compensation is $35,000.
•
Aaron and Janelle have total allowable itemized deductions of $12,000.
•
Aaron and Janelle have two dependent children.
•
Aaron and Janelle have other economic income as follows:
– Interest on U.S. Treasury notes $1,000.
– Interest on Compost Computer bonds $1,500.
– Interest on German government bonds $750.
– Interest on City of Nashville. bonds $1,200.
– Aaron’s wealthy uncle gives him $1,000.
– Janelle sold Aaron’s football card collection for $3,000. It cost $800.
– Janelle sells Aaron’s fishing boat for $2,000. Aaron had purchased the boat 3 years
ago for $2,800.
Based on the above information, what is Aaron and Janelle ‘s adjusted gross income?
a.
$114,450
b.
$114,700
c.
$115,450
d.
$116,450
e.
$116,650
c
93. The information that follows applies to the current year for Revis and Patrica, a married couple.
•
Revis is employed as a shoe salesman; his compensation is $65,000.
•
Patrica is employed as an interior designer; her compensation is $90,000.
•
Revis and Patrica have total allowable itemized deductions of $15,000.
•
Revis and Patrica have two dependent children.
•
Revis and Patrica have other economic income as follows:
– Interest on U.S. Treasury bonds $1,000.
– Interest on French government bonds $750.
– Interest on City of Miami, Fla. bonds $1,200.
– Patrica won $500 from the state lottery
– Revis’s wealthy uncle dies and leaves him $10,000.
– Patrica sold Revis’s baseball card collection for $3,000. Revis bought it for $800.
– Patrica sells Revis’s fishing boat for $2,000. Revis had purchased the boat for
$2,500.
Based on the above information, what is Revis and Patrica ‘s taxable income?
a.
$126,150
b.
$129,950
c.
$128,650
d.
$144,450
e.
$159,450
c
94. Melissa owns 40,000 shares of Wilkerson Corporation common stock that cost $99,000 four years ago. During the
current year, Wilkerson distributes a 10% stock dividend to shareholders. Melissa receives 4,000 new shares when the
market value of the stock is $9 per share. Later in the year, the corporation distributes a cash dividend of $0.50 per share.
What are the tax effects of these distributions to Melissa?
I.
The $22,000 cash dividend is included in gross income.
II.
The $36,000 stock dividend is included in gross income.
III.
Only $20,000 of the cash dividend is included in gross income.
IV.
At the end of the year, the per share basis in the stock is $2.25.
a.
Statements I and II are correct.
b.
Statements III and IV are correct.
c.
Statements I and IV are correct.
d.
Only statement IV is correct.
e.
Only statement I is correct.
c
95. Jacob is experiencing cash flow problems during the current year. Rather than put the $80,000 business loan in
default, his bank agrees to reduce the debt to $50,000. Prior to the debt reduction, Jacob’s total assets were $500,000 and
his total liabilities were $490,000. How much income must Jacob recognize from the reduction of his bank loan?
a.
– 0 –
b.
$10,000
c.
$20,000
d.
$30,000
96. Milton is experiencing cash flow problems during the current year. Rather than foreclose on the $120,000 mortgage
Chapter 4
loan on his principal residence, his bank agrees to reduce the debt to $90,000. Prior to the debt reduction, Milton’s total
assets were $400,000 and his total liabilities were $390,000. How much income must Milton recognize from the reduction
of his bank loan?
a.
– 0 –
b.
$10,000
c.
$20,000
d.
$30,000
a
97. Cary is experiencing cash flow problems during the current year. Rather than foreclose on an $80,000 business loan,
his bank agrees to reduce the debt to $50,000. Prior to the debt reduction, Cary’s total assets were $500,000 and his total
liabilities were $510,000. How much income must Cary recognize from the reduction of his bank loan?
a.
– 0 –
b.
$10,000
c.
$20,000
d.
$30,000
c
98. Discharges of debt are generally taxable. However, in certain circumstances, part or all of the income from a discharge
of indebtedness may be excluded. Which of the following concepts form(s) the basis for the income tax treatment of a
discharged debt?
I.
Wherewithal-to-Pay Concept.
II.
Legislative Grace Concept.
III.
Realization Concept.
IV.
Substance Over Form Doctrine.
a.
Statements I and III are correct.
b.
Statements II and III are correct.
c.
Statements I and IV are correct.
d.
Statements I, II, and III are correct.
e.
Statements II, III, and IV are correct.
99. Harry owed $10,000 to his employer. The employer forgave the indebtedness due to Harry’s hard work. Also, Harry
allowed the holder of the mortgage on his vacation home to foreclose on the property. Although Harry is solvent, he
wanted to get out from under the indebtedness. Therefore, the vacation home, which had a fair market value of $200,000,
an original cost of $180,000, and a mortgage encumbering the property of $200,000, was surrendered. How much gross
income resulted from these events?
a.
$- 0 –
b.
$10,000
c.
$20,000
d.
$30,000
e.
$210,000
100. Ormont Corporation owed Landry Inc., $250,000. Ormont became pressed for cash and was unable to pay the
Landry debt when it came due. Rather than force Ormont into bankruptcy, Landry agrees to reduce the debt to $200,000.
In which of the following cases will Ormont be required to recognize income from the discharge of the Landry debt?
Chapter 4
Total Liabilities
Total Assets Before Discharge
a.
$2,000,000 $2,020,000
b.
$2,000,000 $3,000,000
c.
$3,000,000 $3,300,000
d.
$3,000,000 $3,050,000
a
101. David owes $120,000 to Second National Bank. David is having financial difficulties during the current year and
Second National agrees to reduce David‘s debt to $80,000 to help him get his financial affairs in order and avoid
bankruptcy.
I.
If David’s assets were $300,000 and his liabilities were $290,000 before the discharge, he is
taxed on $10,000 of the $40,000 debt reduction.
II.
If David’s assets were $300,000 and his liabilities were $400,000 before the discharge, he is
not taxed on any of the $40,000 debt reduction.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
102. Gus owes $50,000 in credit card debt to Neighbor’s Bank. Gus was having financial difficulties during the current
year and Neighbor’s Bank agreed to reduce Gus’s debt to $20,000 to help him get his financial affairs in order and avoid
bankruptcy.
I.
If Gus’s assets were $100,000 and his liabilities were $150,000 before the discharge, he is
not taxed on any of the $30,000 debt reduction.
II.
If Gus’s assets were $80,000 and his liabilities were $100,000 before the discharge, he is
taxed on all $30,000 of the debt reduction.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
a
103. Chipper borrowed money from several creditors for personal uses. At a time when his assets are worth $120,000 and
his debts are $140,000, his creditors agree on a compromise settlement in which they forgive $26,000 of the debt. How
much of the $26,000 is included in Chipper’s Gross Income?
a.
$- 0 –
b.
$6,000
c.
$13,000
d.
$20,000
e.
$26,000
104. Bob and Linda purchased their vacation home in 2012 for $400,000. They financed the purchase with a $350,000
mortgage. In 2015, they fall upon hard times and cannot make the mortgage payments, and their mortgage is foreclosed.
Chapter 4
The mortgage company sells the house for $300,000. At the time of the sale, the mortgage balance is $325,000. The
mortgage company cancels the remaining debt on the mortgage. How much income do Bob and Linda have from the
cancellation of the remaining debt on their home?
a.
$- 0 –
b.
$25,000
c.
$75,000
d.
$100,000
105. Edward and Inez purchased their home in 2002 for $600,000. They financed the purchase with a $550,000 mortgage.
In 2015, they fall upon hard times and cannot make the mortgage payments. They sell their home for $425,000. At the
time of the sale, the mortgage balance is $450,000 on their home. The mortgage company cancels the remaining debt.
Which of the following is true?
I. Edward and Inez will recognize no income on the cancellation of the mortgage loan.
II. Edward and Inez will realize a loss on the sale of their home.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
106. Eduardo and Ana Maria own their home, purchased in 2003 for $600,000. They financed the purchase with a
mortgage for $550,000. In 2011 they bought a vacation cottage for $100,000, financed with a second mortgage of $95,000
on their home. In 2015, they fall upon hard times and cannot make the mortgage payments. The mortgage company sells
their home for $425,000 and the cottage for $85,000. At the time of the sale, the mortgage balances are $450,000 on their
home and $90,000 on their second mortgage. The mortgage company cancels the remaining debt. How much income do
Eduardo and Ana Maria recognize on the cancellation of their debt?
a.
$-0-
b.
$5,000
c.
$15,000
d.
$25,000
e.
$30,000
107. Joan purchased her residence in 2010 for $500,000 by borrowing $450,000. In 2015, she becomes unemployed and
can no longer afford to make the full monthly payment on the mortgage. When the mortgage balance is $430,000, the
bank agrees to reduce her mortgage to avoid foreclosure. How much income would Joan have to recognize if the bank
agrees to reduce the mortgage on the residence to $300,000?
a.
$- 0 –
b.
$20,000
c.
$30,000
d.
$50,000
e.
$80,000
a
108. Jolie purchased her residence in 2010 for $500,000 by borrowing $450,000. In 2015, she becomes unemployed and
Chapter 4
can no longer afford to make the full monthly payment on the mortgage. When the mortgage balance is $430,000, the
bank agrees to reduce her mortgage to avoid foreclosure. What is Jolie’s basis in her residence if the bank agrees to reduce
the mortgage on the residence to $300,000?
a.
$- 0 –
b.
$300,000
c.
$370,000
d.
$430,000
e.
$500,000
c
109. In July, Bruce leases a building to Vanessa for a period of twenty years at a monthly rental of $1,500. As part of the
lease agreement, Vanessa pays a $3,000 security deposit. In addition, the lease agreement states that any improvements
that Vanessa made to the building become Bruce’s property. Prior to moving in on July 1, Vanessa makes improvements
to the building at a cost of $13,000. How much gross income does Bruce have from the lease arrangement in the first year
of the lease?
a.
$9,000
b.
$12,000
c.
$22,000
d.
$25,000
e.
None of the above.
a
110. Benton leases a Park City condominium from Walnut Rental for $750 a month. Benton operates a carpet store in
Park City. During October and November Benton does not make his monthly payments. Instead, Walnut allows him to
replace the carpeting in another rental property of his instead of paying rent. What is Walnut’s tax treatment of these
events?
I.
Walnut can capitalize the $1,500 and depreciate it.
II.
Walnut can deduct the $1,500 as an operating expense.
III.
Walnut includes the $1,500 in its gross income for the year.
IV.
The $1,500 must be added to the basis of the condominium.
a.
Statements II and III are correct.
b.
Statements I, II, and III are correct.
c.
Statements I and III are correct.
d.
Only statement II is correct.
e.
Only statement I is correct.
a
111. Which of the following statements is/are correct?
I.
Terry’s divorce decree provides that his ex-wife is to pay him alimony of $500 per month
until their son reaches age 18 or dies, at which time the payment will be reduced to $300.
Terry recognizes $300 of alimony income each month.
II.
Jerry is the manager of Northgate apartments. He is required to live in an apartment in the
complex that normally rents for $600 per month. Jerry must recognize $600 per month as
income from his management job.
III.
Lorraine’s aunt dies during the current year. The aunt’s $20,000 life insurance policy names
Lorraine as the beneficiary. Lorraine receives $20,000 from the policy in December.
Lorraine must include the $20,000 in her gross income.
IV.
Helen receives a teaching assistantship from the music department that pays her $300 per
Chapter 4
month. Helen must work as a lab assistant 15 hours per week. Helen’s total direct education
costs are $9,000. Helen includes the $300 per month in her income.
a.
Statements I and IV are correct.
b.
Statements II and III are correct.
c.
Statements II and IV are correct.
d.
Statements I and III are correct.
112. Which of the following statements is/are correct?
I.
Danny falls off a ladder at work and is hospitalized for two weeks. He receives $650 from
the state worker’s compensation fund, his regular $1,800 salary, and $925 disability pay
from his employer’s health and accident insurance plan. Danny must recognize $2,725 of
income from the payments.
II.
Donna’s grandfather dies and leaves her City of Goldsboro bonds that are worth $57,000.
The bonds have a face value of $50,000 and pay 5% annual interest. Donna must include the
$2,500 of interest she receives in her gross income.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
113. Which of the following statements is/are correct?
I.
Belle is retired. Her only sources of income are her $1,500 per month pension and $12,000
of Social Security benefits. Belle must include $6,000 of the Social Security benefits in her
gross income.
II.
Eileen and Daren divorce during the current year. Per the divorce agreement, Daren is to
receive alimony of $600 per month, $400 per month for child support, and the family house
that is valued at $200,000. Daren must recognize $600 per month as income.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
114. For each of the following situations, determine the amount of gross income that the taxpayer should recognize.
Explain why any amounts are excluded from gross income.
a.
Harvey is injured in an automobile accident. The driver of the other car is found to be at fault.
A judge awards Harvey $10,000 for pain and suffering, $20,000 in punitive damages, and
$15,000 for medical expenses. Harvey’s total medical costs are $25,000 and his employer
provided insurance policy pays $8,000 of the remaining medical costs. He also receives $800
of worker’s compensation while he was unable to work. In addition, his employer provided
insurance pays him $450 of disability pay while he recuperated and a separate plan that Harvey
purchased paid $300 of disability payments.
b.
Heather owes $35,000 of credit card debt to First City Bank. Heather is having financial
difficulties during the current year and First City agrees to reduce her debt to $20,000 to help
Chapter 4
her get her financial affairs in order and avoid bankruptcy. Heather’s assets were $100,000 and
her liabilities were $110,000 before the discharge.
c.
On May 1, Ernie receives 1,000 shares of Glimmer Company stock as a graduation present
from his uncle. The shares have a fair market value of $5 per share on May 1. Ernie receives an
additional 100 shares on July 25 as a result of a 10% stock dividend that Glimmer had declared
on July 1. On December 1, Glimmer declares and distributes a $.50 per share cash dividend.
d.
Garry works as a reservations clerk for Big Apple Hotels. Big Apple Hotels also owns
Mideastern Airlines. Big Apple allows all employees to fly on Mideastern Airlines and to stay
in Big Apple Hotels free, on a space available basis. Garry takes advantage of Big Apple’s
generosity and took a trip to Reno to visit the casinos. The cost of the airfare would have been
$480 and the lodging would have cost $600 if he had not been an employee of Big Apple.
Heather has $5,000 of gross income from the discharge. Because she was insolvent before the
discharge, she can exclude the discharge from income. However, if the discharge makes her
$15,000 debt reduction makes her solvent by $5,000 [$100,000 – ($110,000 – $15,000)].
excluded from income. The stock dividend shares are not subject to tax. The cash dividend
d.
Garry has gross income of $480 from the free airfare. Employee’s can exclude the value of no
services are non-discriminatory, but the free airfare does not qualify for exclusion because
115. For each of the following situations, determine the amount of gross income that the taxpayer should recognize.
Explain why any amounts are excluded from gross income.
a.
Gary is an employee of G&K Electronics. G&K allows all employees to buy goods from
inventory at a 20% discount. Gary purchases a television under the discount plan for $800. The
television, which cost G&K $700, normally sells for $1,000.
b.
Carolyn receives an $8,000 National Merit Scholarship and a $2,000 Honors at Entrance
Scholarship to attend State Tech. The scholarships were given based on national testing scores
and high school grades, and require no future services on Carolyn’s part. Tuition and other fees
are $6,500 per year at State Tech. Carolyn also pays $6,000 for room and board in University
housing.
c.
Donnie’s employer provides free parking to certain management level employees. In 2014,
Donnie’s employer provided parking cost his employer $3,180.
d.
Gretchen receives $5,000 of 6% City of Orlando bonds as a graduation present from her
boyfriend on May 1. The bonds pay interest on June 30 and December 31. Gretchen sells the
bonds at a gain of $750 in August.
Chapter 4
Gary does not have any gross income from the qualified employee discount on goods. The
G&K’s normal 30% gross profit percentage.
Donnie must include the value of the parking in excess of the $3,000 excluded amount in his
Gretchen has $750 of income from the sale of the bonds. The receipt of the bonds is an
116. 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.
Leon works for Golfshop America, a large retailer of golf items. Golfshop allows all
employees to purchase golf items at a 40% discount. Leon purchases a set of golf clubs for
$700 that normally sells for $1,000 (cost of the golf clubs to Golfshop was $600). In addition,
Leon is selected as salesman of the year and receives a gold putter worth $900.
b.
Brenda is a student at Atlantic University. Brenda pays the $15,000 cost ($10,000 for tuition
and books; $5,000 for living expenses) of attending Atlantic University with a $5,000 general
scholarship from the college of economics, a $5,000 student loan, and $3,000 from her parents.
c.
Becky pays off the loan on her son’s car while he is a student at State University. The son,
Daryl, owed $5,400 before Becky made the payment.
d.
Leona is injured while on the job. She receives $4,000 from workers’ compensation during the
time she was away from her job.
gross profit percentage of the goods purchased. The receipt of the putter is a form of
compensation and must be included in Leon’s gross income at its fair market value. It is not an
b.
Brenda has no income. The general scholarship is less than tuition and books and is excluded.
c.
The debt relief would be considered a gift due to the relationship between Becky and Daryl.
d.
Workers’ compensation payments are excluded from gross income. They are characterized as a
117. 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.
Cory is an employee of Simmons, Inc. Several years ago Cory purchased a used bus from
Simmons. The bus had an adjusted basis of $30,000. Cory agreed to pay $20,000 (the fair
Chapter 4
market value of the bus) for the bus if Simmons would finance the purchase over four years.
During the current year, when the debt on the bus was $5,000, Simmons told Cory that he
didn’t have to make any more payments on the bus because of his perfect safety record over the
last five years.
b.
Several years ago Lauren’s grandfather gave her $10,000 worth of City of Eau Claire,
Wisconsin bonds. After receiving $400 of interest in the current year, she sells the bonds for a
gain of $800.
c.
Portal Corporation employs Berry at an annual salary of $40,000. Portal provides a qualified
pension plan into which all employees are permitted to contribute up to 6% of their annual
salaries. Portal matches contributions dollar-for-dollar. Berry contributes 6%.
d.
Carla, a student at State College, receives a $3,000 scholarship for her grades in previous years.
She also earns $6,000 from a part time job. Her annual costs are $6,000 for tuition, books and
supplies and $7,000 for room and board. Her parents pay the remaining $4,000 of her college
costs.
Cory has $5,000 of income from the discharge of debt. The sale of the bus was entered into at
Lauren has $800 of income (long-term capital gain) from the sale of the bonds. The value of
income. However, these amounts are taxable when withdrawn at retirement. The amounts
Carla has gross income of $6,000 (part-time job). The scholarship is excluded because it is less
118. What are the differences between a cafeteria plan and a flexible benefits (salary reduction) plan?
used to pay for medical, child-care or certain other expenses. The amounts withheld are not included in the
119. Christine, age 23, is an employee of Higgins Hardware Distributors whose annual salary is $35,000. Higgins
provides employees with free group-term life insurance at twice their annual gross salary, free health and accident
insurance, a qualified pension plan, and a flexible benefits plan. Christine’s health and accident insurance cost Higgins
$1,920. The cost of her group-term life insurance coverage is $520. Higgins pension plan allows employees to contribute
up to 6% of their annual salary, which Higgins matches. Christine elects to have the maximum pension plan contribution
made into the plan and has $400 of her salary paid into the flexible benefits plan. She submits medical insurance claims
totaling $900 to the health insurance policy and is reimbursed $550. She receives the remaining $350 of medical insurance
claims from the flexible benefits plan. How much gross income does Christine have from her employment with Higgins?
120. Bonita, age 23, is an employee of Watson Hardware Distributors whose annual salary is $40,000. Watson provides
employees with free group-term life insurance at twice their annual gross salary, free health and accident insurance, a
qualified pension plan, and a cafeteria plan. Bonita’s health and accident insurance cost Watson $1,920. The cost of her
group-term life insurance coverage is $520. Watson pension plan allows employees to contribute up to 6% of their annual
salary, which Watson matches. Bonita elects to have the maximum pension plan contribution made into the plan.
Watson’s cafeteria plan provides for $4,000; she elect to have dental coverage for $3,000 and elects to take the other
$1,000 in cash. She submits medical insurance claims totaling $900 to the health insurance policy and is reimbursed $550.
She receives the remaining $350 of medical insurance claims from the flexible benefits plan. How much gross income
does Bonita have from her employment with Watson?
121. Darren is a single individual who worked the entire year for Woodworks Company in Brazil. He paid $15,000 in
Brazilian taxes on his Woodworks salary of $70,000. What is Darren’ lowest tax liability if his taxable income is $40,000,
before considering the Woodworks salary?
122. Isabel, age 51 and single, is an electrical engineer employed by Regis Corporation. Isabel’s annual salary is $80,000.
Regis Corporation’s qualified pension plan matches employee’s contributions to the plan up to 5% of the employee’s
annual salary. During the current year, Isabel contributes the $4,000 maximum to the plan, which is matched by Regis.
Due to high cost of medical insurance, the corporation does not provide any medical insurance to its employees. Instead, it
offers a flexible benefits plan that employees can use to pay for medical insurance, unreimbursed medical costs, and
childcare costs. Isabel elects to have $2,500 paid into the plan. Isabel uses the plan to purchase medical insurance costing
$2,200. Isabel spends an additional $150 from the plan on eyeglasses and dental costs. Regis Corporation also provides
group-term life insurance at twice the employee’s annual gross salary. The cost of Isabel’s insurance was $600. Regis also
provides engineers in Isabel’s department with free parking in the company’s parking garage. Non-employees pay $3,060
per year to park in the garage. Isabel’s $250 dues to the Electrical Engineer’s Association and her $1,560 health club
membership are also paid by Regis. Compute Isabel’s taxable compensation from Regis Corporation.
Gross salary
excess of $50,000:
Health club membership
Taxable compensation
membership is taxable to Isabel. It is not a qualified employer’s athletic facility.
123. Todd, age 26 and single, is an employee of the Ice Corporation. Todd‘s annual salary is $50,000. Ice has a qualified
pension into which employees may contribute 5% of their annual salary (Todd contributes the maximum). The
corporation also offers employees a flexible benefits plan. Todd pays $500 into the plan and is reimbursed for $500 of
Equals Tax on $40,000
Tax on $110,000
Tax credit for Brazilian tax paid
$15,257. Because $15,000 is less than $15,191, the full foreign tax of $15,000 can be taken as a credit.
Chapter 4
medical expenses not covered by his medical insurance. Ice also provides Todd with the following benefits:
Medical insurance
$3,200
Group-term life insurance ($80,000 of coverage)
900
Free-parking
3,180
Dues to professional organizations
300
Health club membership
860
What is Todd’s taxable income from his employment?
Salary
payment
Health club membership
Taxable income
124. Graham and Lucy purchased their home in 2003 for $400,000. They finance the purchase with a $350,000 mortgage.
In 2011, when their original mortgage balance was $340,000, they took out a second mortgage for $100,000 and added a
second garage. In 2015, they fall upon hard times and cannot make the mortgage payments. The mortgage company sells
their home for $350,000. At the time of the sale, the mortgage balances are $330,000 on their home and $90,000 on their
second mortgage. The mortgage company cancels the remaining debt. What are the income tax consequences of the sale
of the residence and cancellation of the debt by the mortgage company?
debt cancellation.
125. Sergio owns Sergio’s Auto Restoration as a sole proprietorship. His business has fallen on hard times and his bank
has agreed to reduce the debt on his warehouse from $175,000 to $150,000. The warehouse, which was purchased in 1995
at cost of $190,000, has a fair market value of $160,000 and an adjusted basis of $140,000. Before the debt reduction
Sergio’s total assets are $680,000 and his total liabilities are $700,000. Discuss the tax effect of the debt reduction and
determine the minimum amount of income Sergio must recognize from the discharge.
126. Simon Leasing, Inc., an accrual basis taxpayer, owns and leases residential, business, and industrial properties.
During the current year it collects $800,000 in rents on its various properties. Included in the $800,000 in rents is $80,000
of the last month’s rent payments it requires on new rentals. The company also receives $30,000 of security deposits on
new residential rentals. In addition, one of its business tenants pays $40,000 to cancel a long-term lease during the year.
Simon Leasing, Inc., also sold one of its industrial buildings for $1,700,000. Simon Leasing had purchased the building
for $900,000 in 1986. The tenant made improvements to the building valued at $100,000 in 1986. At the termination of
the original lease last year, the building was worth $1,600,000 ($150,000 of that was attributable to the improvements
made by the tenant) and the adjusted basis was $500,000. The adjusted basis at the date of sale is $460,000. How much
income must Simon Leasing, Inc., recognize in the current year? Explain how you arrived at the gross amount in terms of
the income tax concepts.
127. Carson, age 34 and single, is an electrical engineer employed by Summit Corporation. Carson‘s annual salary is
$84,000. Summit Corporation’s qualified pension plan matches employee’s contributions to the plan up to 5% of the
employee’s annual salary. During the current year, Carson contributes the $4,200 maximum to the plan, which is matched
by Summit. Due to high cost of medical insurance, the corporation does not provide any medical insurance to its
employees. Instead, it offers a flexible benefits plan that employees can use to pay for medical insurance, unreimbursed
medical costs, and childcare costs. Carson elects to have $2,500 paid into the plan. Carson uses the plan to purchase
medical insurance costing $2,100. Carson spends an additional $650 from the plan on eyeglasses and dental costs. Carson
has asked you to prepare his tax return. Your initial interview with him discloses that he has $1,050 of allowable
deductions for adjusted gross income and $3,700 of allowable itemized deductions.
a.
Compute Carson’s taxable income and his tax liability.
b.
After your initial interview, Carson calls you and says that he just received two statements
concerning sales of investments that he had forgotten about. On January 15, he sold shares of
stock for $5,500. Carson purchased the stock in November for $4,500. He also received
$2,000 on March 15 from the sale of some land that he had received as an inheritance from his
grandfather in 2000. He has a statement from the executor of his grandfather’s estate listing his
basis in the land at $10,000. Explain the effect of these two sales on Carson’s taxable income
and his tax liability.
income to the extent the discharge makes them solvent. Because Sergio is solvent by $5,000 [$680,000 –
$25,000 discharge under this provision.
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or
128. Summary Problem: Ralph, age 44, is an account executive for Cobb Advertising, Inc. Ralph’s annual salary is
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$90,000. Other benefits paid by Cobb Advertising were:
Health and Accident Insurance Premiums
$1,500
Group-Term Life Insurance Policy ($135,000 of coverage)
250
Payment of Country Club Dues
3,660
Dues to professional organizations, trade journals
550
Parking space in downtown garage
3,180
In addition to the benefits above, Cobb Advertising has a qualified pension plan into which employees can contribute (and
Cobb matches) up to 5% of their annual salary. Ralph contributes the maximum allowable to the plan.
Ralph has never been able to itemize his allowable personal deductions (i.e., he always uses the standard deduction). In
2015, Ralph receives a refund of $300 of his 2014 State income taxes and a 2014 Federal tax refund of $400.
Other sources of income:
Interest credited to savings account
$980
Value of stock received from Western
Power & Light Company
(Ralph had the option to take the
dividend in cash)
400
Sale of Sea Island Adventures
Common Stock
(cost of the stock was $2,200)
3,500
Value of land inherited from
grandfather
80,000
Crop-share payments received on
inherited land
2,820
Required: Compute Ralph’s 2015 gross income.
Salary
Less: Pension Plan Payment ($90,000 × 5%)
Group-Term Life Insurance (85 × $1.20)
Country Club Dues
Free Parking [$3,180 – ($250 × 12)]
Interest on Savings Account
Stock Dividend with cash option
Gain on Sale of Stock ($3,500 – $2,200)
Crop-share Payments
Total Gross Income
129. Summary Problem: Tommy, a single taxpayer with no dependents, has the following items that may affect his
taxable income. What is his adjusted gross income?
Employee salary received
$70,000
Child support paid to ex-wife
12,000
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Total allowable itemized deductions
3,000
Cash gift received from parents
7,000
Gain on the sale of stock
5,000
Loss on the sale of personal residence
(10,000)
Loss on the sale of stock
(6,000)
Amount collected from a life insurance policy
40,000
Health insurance premiums paid by his employer
3,000
Winnings from gambling trip to Las Vegas
800
Cost of employer paid parking space
1,200
Government pension benefits received
15,000
Amount his dog earned from being in a television commercial
2,000
Gain on stock
Loss on stock
Gambling winnings
Dog commercial
Adjusted gross income
A salary reduction plan that allows employees to pay for medical and child care costs with before-tax dollars.
A transfer of property without any profit motivation with an intention that includes affection, charity, and respect.
130. Cafeteria plan
131. Child & dependent care
132. De minimus fringe
133. Flexible benefits plan
134. Gift
135. Qualified pension plan
Match each statement with the correct term below.
a.
Dues, uniforms, subscriptions.
b.
Intended to punish and are taxable.
c.
Taxable if from an employer-provided policy.
d.
Any personal wrong, such as libel, slander, or assault.
e.
Excludable amount limited to gross profit percentage.
f.
Gratuitous and not a form of compensation for services.
g.
Excludability requires that it must be a condition of employment.
h.
Excluded if for compensatory payments for sickness or personal physical injury.
i.
To replace lost earnings and is excluded if due to personal physical injury.
j.
Excluded if provided on the employer’s business premises and for the convenience of employer.
136. Damage payments
137. Disability payment
138. Employee discount
139. Employer-provided lodging
140. Loss-of-income damages
141. Meals provided by employer
142. Personal injury
143. Punitive damages
144. Scholarship
145. Working condition fringe
Each of the numbered items below is accorded only one of the following lettered treatments. Use the existing law as it
applies to the current year, match the best answer to the statements below.
a.
Fully excluded from gross income.
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b.
Fully included in gross income.
c.
Partially excluded from gross income.
146. Laura’s employer pays the first $5,000 in childcare benefits under their childcare assistance plan.
147. Michelle’s employer pays for her graduate school classes. Tuition during the year totals $2,500 (her employer does
not have a qualified plan).
148. Frank receives $1,000 interest income from City of St Louis bonds.
149. Katrina receives $1,000 interest income from U.S. Treasury bonds that her uncle had given to her.
150. Tina receives 100 shares of Welby stock as a result of a 2 for 1 stock split. The shares have a value of $7,000 the day
of the split.
151. Raymond dies on July 8th of the current year. Out of love and respect for Raymond, his employer gives his widow
$5,000.
152. Julian’s tenant improves her side of the duplex by making improvements to the bathroom and kitchen that are worth
$750. Julian does not adjust her rent for the $750 improvements.
153. Sarah, the managing partner in an accounting firm, has her downtown parking space ($325/per month) paid by the
firm. None of the accounting staff receive parking privileges.
154. Jeane’s employer pays his medical premiums each month ($130/month).
155. Jeane’s medical insurance carrier reimburses him 80% of his qualified medical expenses. During the current year
Jeane receives $3,682 in payments.
156. Julia receives $6.3 million in compensatory damages for a personal physical injury.
157. Marline receives $14 million in punitive damages for a personal physical injury.
158. Kenneth receives a new Ford Explorer worth $28,900 that his parents bought him for his 24th birthday.
159. Dick lives rent-free in an apartment (value $675/month) in a complex where he is the apartment manager and must
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be on the premises to handle problems.
160. David’s employer laid him off for three months during the slow winter season. He collects $4,375 in unemployment
compensation.
161. Hank’s employer gives him fishing gear that is worth $1,250 at his retirement party.