5
Gross Income
Solutions to Tax Return Problems
5-52 The treatment of the various items is discussed below.
1. David’s salary of $70,000 is taxable and is reported on line 7 of Form 1040.
The withholding is treated as a credit against the taxes owed and is reported
on line 54 of Form 1040.
2. The $3,000 bonus is taxable as wages. The bonus is reported in the current
year under the doctrine of constructive receipt. As a practical matter, the
bonus should be included with the wages reported on his W-2.
3. The total sales price of the bond must be reduced by the $700 of interest
accrued to the date of the sale. This interest is reported as interest income on
line 8. The sale of the bond results in a capital loss of $1,000 ($9,000 –
$10,000). This amount should be reported on Schedule D and line 13.
4. The Gibbs report none of the $30 as income because they do not own the
bonds. Income from property is taxed to the owner of the property.
5. The lottery winnings of $50 are fully taxable.
6. The sale of the stock results in a long-term capital loss of $4,000 ($10,000 –
$14,000). The loss is reported on Schedule D.
7. Barbara’s income from self-employment of $5,000 is reported on Schedule C
along with the deduction of $100 for the software. The net income of $4,900
is subject to self-employment tax.
8. The medical expenses of $7,468 are deductible to the extent they exceed 7.5%
of the couple’s A.G.I. or $1,820 [$7,468 – (7.5% × $75,304 = $5,648)]. The
mortgage interest $8,500 on a primary or secondary residence is fully
deductible, as are the property taxes of $5,000, state income taxes of $3,750
and the charitable contributions of $2,000 for a total of $21,070. Because the
itemized deductions exceeds the standard deduction, it is better for the
taxpayers to itemized their deductions.
9. The Gibbs are entitled to the child tax credit since both children are less than
17 years of age and are claimed as dependents. The credit is $1,000 per child
for a total of $2,000. The child tax credit is phased out if income exceeds a
certain threshold but the Gibbs income does exceed this amount so the phase-
out does not apply and consequently the Gibbs are allowed the entire credit of
$2,000.
10. The solution ignores the temporary reduction in the self-employment tax in
2012.
Tax Return Problem 5-52
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Solutions to Tax Research Problems
5-53 The taxation of free samples is unclear and has generated little litigation. Under a
rigorous application of the Glenshaw Glass doctrine, which takes an all-inclusive
approach to income, the samples would be taxable even if the taxpayer took the
unusual step of returning the sample. It is doubtful whether the courts would take
such an extreme view, however. No doubt the IRS normally assumes that the
samples are of such little value that their taxation is not warranted.
Nevertheless, in Revenue Ruling 70-498, 1970-2 C.B. 6, free books provided
to a book reviewer were considered income when the books were given to a
charity and a charitable deduction was claimed. The Seventh Circuit held
similarly in Haverly v. U.S. [513 F.2d 224 35 AFTR2d 75-1082, 75-1 USTC
¶9326 (CA-7, 1975)], where the principal of a public school received sample
textbooks sent by publishers and claimed a charitable contribution deduction for
the donation of the books to the school.
5-54 This situation concerns proper identification of the taxpayer. Specifically, to
whom is income for personal services taxable if earned by a person who, under a
vow of poverty, is required to turn over the earnings to a religious order? In
Revenue Ruling 76-323, 1976-2 C.B. 18, two taxpayers were members of a
religious order that required them to turn over all of their income while the order
paid their living expenses. In this situation the taxpayers obtained employment as
plumber and construction worker respectively and directed that their earnings be
paid to the order. The Court held that the income was taxable to the taxpayers
because it was their income. Although a charitable contribution deduction was
allowed for the payments to the order, it was restricted to the normal percentage
limitations (50% adjusted gross income). Also see Revenue Ruling 77-290, 1977-
2 C.B. 26 for a similar holding. In contrast, Revenue Ruling 68-123, 1968-1 C.B.
35 considered a situation where the religious order’s purpose is to supply
personnel to missions, hospitals, and schools. The order negotiated for these jobs
on behalf of its members. The order assigned a nurse to work at a hospital and
made all the arrangements for the job. The ruling held that the taxpayer nurse was
an agent of the order and was not taxable on the payments made by the hospital to
her.
Given these rulings, it would appear that taxation of the earnings to R depends
on whether she is considered an agent of the order. If the order negotiates a job
position for her and makes all the necessary arrangements, the Service would
allow R to escape taxation. Conversely, if R finds her own job and simply directs
that her earnings be paid over to the order, she would be taxed on the earnings.
(Also see Letter Ruling 8105008.)
5-55
a. This is a simple illustration of the assignment of income doctrine originally
enunciated in Lucas v. Earl (see footnote 87 on p. 5-35; see also Seatree 25
BTA 396.) According to this doctrine, income is taxed to the taxpayer who
earned the income, which in this case is clearly Dr. A. Under the assignment
of income doctrine, Dr. A is responsible for the income because he earned it.
(See p. 5-35.)
b. Whether R has income depends primarily on the extent to which he
participated in the contract negotiations and whether or not he has the right to
receive or direct the use of funds. Revenue Ruling 53-71, 1953-1 C.B. 18
indicates that if the individual’s employer or superior makes his services
available to a third party, and the individual neither participates directly in the
contractual arrangements, nor has the right to receive or direct the use of the
amounts paid, the amounts will not be included in income. See also Revenue
Ruling 68-503, 1968-2 C.B. 44. See also Revenue Ruling 77-121, 1977-1 C.B.
17, where a pari-mutuel race track that donated “Charity Day” race proceeds
to an exempt charitable organization did not have includible income.
Note that the issue is significant, notwithstanding the fact that R would be
entitled to a charitable contributions deduction if he performed the services,
received payment, and then contributed the proceeds. This is true because the
charitable contribution deduction is limited to 50 percent of the taxpayer’s
adjusted gross income.
c. The issue in this situation is whether the power to dispose of income is the
equivalent of ownership of it. Early decisions concerning this question
answered in the affirmative. (See, for example, Helvering v. Horst (footnote
82), and Revenue Ruling 58-127, where a taxpayer submits an entry in a
contest and wins a prize payable to his child.) In Teschner, 38 T.C. 1003
(1962), however, the Court ruled that the assignment of income doctrine
applies only when the assignor is entitled to receive the income, or has the
right to receive it and subsequently assigns it away. An individual cannot
escape taxation on income to which he is entitled by turning his back on the
income; however, he must have the right to receive the income. Here the
taxpayer (T) does not have that right, and thus the income is not taxable to
him.
5-56 When property is transferred to satisfy a debt, the transaction is the economic
equivalent of a sale of the property for cash that is used to pay off the debt. The
principal question raised in such a situation (which is the case here) is whether the
transfer does in fact trigger recognition of gain. The problem was aptly stated in
the landmark case of U.S. v. Davis, 370 U.S. 65 (1962) where, pursuant to a
divorce agreement, the taxpayer transferred appreciated stock to his spouse in
settlement of his marital obligations. According to the Court, there was little
“doubt that Congress, as evidenced by its inclusive definition of income subject to
taxation (i.e., ‘all income from whatever source derived, including … [g]ains
derived from dealings in property’), intended that the economic growth of this
stock be taxed. The problem confronting us is simply when is such accretion to be
taxed.”
Since the Supreme Court’s decision in Eisner v. Macomber, it is generally
presumed that the appreciation in the value of property is not taxed until it has
been “realized” in some manner. However, this principle is not explicitly adopted
in the Code and should not be considered sacrosanct. Many commentators have
indicated that the taxation of unrealized appreciation is not unconstitutional. In
this regard, economists have argued that holding an asset is the functional
equivalent of selling the asset and reinvesting the proceeds in the same asset.
Nevertheless, conventional wisdom assumes that the realization principle is
implicit in §61(a)(3), which provides that income includes gains derived from
dealings in property. Likewise, § 1001, in prescribing the method for computing
gains and losses, implicitly adopts the realization principle, referring to gains or
losses derived from “the sale or other disposition of property.”
It should be emphasized that the Code sections alluded to above should not be
construed to mean that in order for there to be realization there must be a sale of
the property. As suggested in the Davis decision, the term disposition, as well as
the all-inclusive definition of gross income contained in §61, are sufficiently
broad to reach all gains regardless of source. Thus, as indicated above, the critical
question in this situation is whether the taxpayer is considered as having
“realized” the income.
In the absence of specific rules contained in the Code or Regulations, the
question of realization in this instance has been left to the courts. In general, the
courts have chosen to distinguish the tax consequences arising from transfers of
appreciated property by gift from those made to satisfy a debt. With respect to a
transfer made to satisfy a debt, the courts have viewed this as being a taxable
event because of its similarity to a sale of the property for cash followed by a
payment of the proceeds to the creditor [see Simms, 28 B.T.A. 988, 1029 (1933)].
This view derives from the implication that the phrase “sale or disposition” (or
alternatively, the term “realization”) suggests that the taxpayer has received
valuable consideration in exchange for his transfer. In contrast, where the transfer
is by gift or bequest, this quid pro quo aspect is lacking.
As a general proposition, Congress has chosen not to analogize gifts and
bequests to sales. This approach is suggested most prominently by § 1015(a),
which requires that the donee assume the basis of the donor where appreciated
property is transferred. The underlying rationale for this basis provision is that the
transfer of property by gift is not a taxable event. Rather, any gain or loss is to be
recognized later when the property is disposed of by the donee. In the case of a
bequest, this same rationale is not so apparent, since the basis of the property is
stepped up or down to its fair market value at date of death. Nevertheless,
Congress has never attempted to tax the appreciation.
As suggested above, the courts generally have required the taxpayer to
recognize gain when appreciated property is transferred in satisfaction of a claim
or when the court has found the requisite quid pro quo. In International
Freighting Corp., 43-1 USTC ¶9334, 135 F.2d. 310 (CA-2, 1943), the employer
recognized gain when stock was transferred to employees under a bonus plan,
apparently on the theory that the employer had received the services of the
employees in exchange for the property although there was no preexisting debt.
Similarly, in General Shoe Corp., 60-2 USTC 9552, 282 F.2d. 9 (CA-6, 1960), an
employer who contributed real estate to an employees’ trust was required to
realize gain. (See also Tasty Baking Co., 68-1 USTC ¶9366, 393 F.2d. 993; Rev.
Rul. 73-345, 1973-2 C.B. 11; and Rev. Rul. 75-498, 1975-2 C.B. 29.) In
McDougal, 72 T.C. 720 (1974), the taxpayer gave another a 50 percent interest in
the capital and profits of a joint venture (a horse and its winnings) as
compensation for services. The Court held that the taxpayer had realized a gain on
the transfer to the extent that the value of the one-half interest exceeded his
adjusted basis. Thus, it would appear clear that the taxpayer in the present
situation must recognize gain on the transfer of property in payment of the claim.
Arguably, it could easily follow that the taxpayer should recognize gain on
any transfer of appreciated property. However, the Service generally has
recognized the distinction between gifts and payments. As early as 1920, the IRS
ruled in O.D. 667, 3 C.B. 52 (see also Rev. Rul. 55-117, 1955-1 C.B. 233) that a
decedent’s estate did not realize gain on transferring property to the residuary
legatees under the will. Although the legatee could be considered as having a
claim against the estate, the claim is not a right to a specified dollar amount, but a
right to receive the property itself, regardless of its value at the time of
distribution. Since the estate is not obliged to pay a specific amount, but rather to
distribute the property, there is no gain or loss inuring to the estate or other
beneficiaries, and consequently the distribution is not a taxable event. In contrast,
however, in Suisman v. Eaton, 15 F.Supp. 113 (D. Ct. Conn., 1935), aff’d per
curiam, 83 F.2d. (CA-2, 1936), the distribution of property to satisfy a bequest of
a specific dollar amount was held to be taxable. [See also, Kenan v. Comm., 114
F.2d. 217 (CA-2, 1940).]
With this background, it is easy to conclude that, like the satisfaction of a
pecuniary bequest, the satisfaction of a charitable pledge with property is a
taxable event. The Service has rejected this argument, however, in Rev. Rul. 55–
410, 1955-1 C.B. 297. According to the ruling, the IRS noted (rather
unsatisfactorily) that it would be inconsistent to treat a charitable gift as both a
gift and a satisfaction of debt. Perhaps the real justification for this position lies in
the inequity that would result without the rule.
Note that without the rule, the taxpayer would be unintentionally trapped for
filling out a pledge card indicating a gift of a specific dollar amount, then
satisfying it with property. This prospect could easily have been avoided by
specifying a gift of particular property. As a result, the taxpayer would not be
taxable on his or her gift of property to the charity.
The above ruling provides a great opportunity for taxpayers. Assume that a
taxpayer has appreciated property worth $100, and for simplicity’s sake, a basis of
$0. Assume also that he pays taxes at the rate of 70 percent. If the taxpayer sold
the property, he would recognize a gain of $100 ($100 – $0), pay taxes of $70
(70% × $100), and consequently keep $30 ($100 sales proceeds – $70 tax). Had
the taxpayer given the property to the charity, he would have been better off than
selling it: the contribution would have produced a tax savings of $70, which is
$40 greater than the $30 that he would have had if he had sold the property.
Because of this possibility, Congress revised the charitable contribution rules in
1970, requiring the taxpayer to reduce the amount of his charitable contribution
by the amount of ordinary income that would be recognized on the sale. Thus, in
the above case there would be no contribution. This rule does not apply where
capital gain property is contributed, however. Consequently, if a taxpayer is
planning to give a certain amount to a charity, he would be well advised to
transfer property equal to such amount in lieu of selling the property and giving
the cash. By so doing, he would reduce the cost of his charitable contribution by
the tax he did not have to pay had he sold the property and contributed the
proceeds.
5-57 The facts of this situation present two issues that should be addressed: (1) Does
the company’s payment of Sellit’s expenses represent taxable income; and (2) if
the payment must be included in gross income, does the taxpayer have an
offsetting deduction for the expenses incurred? The leading cases on this issue are
Patterson v. Thomas, 61-1 USTC ¶9310, 289 F.2d 108 (CA-5, 1961) rev’g and
rem’g 59-2 USTC ¶9734 (D. Ct. No. Alabama, 1959) and C.J.D. Rudolph, 62-2
USTC ¶9543 (USSC, 1962).
In Patterson v. Thomas, the taxpayer, J. C. Thomas, was employed by Liberty
National Life Insurance Company as an insurance salesman. By attaining certain
standards of this employer, he was invited into the membership of company’s
Torch Club, composed of outstanding field representatives. As part of his
admittance to the membership, he was asked to attend the company’s annual
Torch Club Convention. Although attendance at the convention was not a
condition of continued employment, failure to attend was frowned upon and
adversely affected the taxpayer’s future promotion. Thomas and his wife attended
the convention, which was held at a resort hotel. Some of his expenses for
attending the convention were paid directly by the employer, and he received
reimbursement for the remainder. On his tax return, Thomas did not report the
reimbursement or direct payment as income nor did he deduct the expenses of his
trip. Upon examination, however, the IRS asserted that the amounts received and
paid on his behalf were income, and more importantly, his expenses were
nondeductible. According to the view of the IRS, the trip constituted the prize in
what in substance was an annual sales contest.
Upon review, the District Court held for Thomas. In the court’s opinion,
attendance at the meeting by the taxpayer served a bona fide business purpose.
The court found that the purpose of the meetings of the Club and the nature of the
programs promoted the professional knowledge, skill, attitude, and morale of
agents and their wives. In addition, it found that the taxpayer was required to
attend. Moreover, while at the meeting he was required to attend the scheduled
activities over which he had no control. The fact that tours and entertainment were
provided did not, in the court’s view, detract from the genuine business character
and purpose of the meeting. The court did not view the meeting as some type of
bonus or reward. As a result, it held that the amounts received did not constitute
gross income; or if they did, then the expenses were deductible by the taxpayer as
ordinary and necessary business expenses.
With respect to the expenses for the wife, the court found that her presence
also served a bona fide business purpose. This was evidenced by the company’s
employment practices. The company interviewed prospective agents’ wives and
sent literature to them on how they could help their husbands to become more
successful in the business. The company believed that it was in the best interest of
its business to take the steps necessary to maintain the loyalty of the wife and
involve her with her husband’s business. The court also noted that the wives’
presence at such meetings ensured a better meeting, eliminating the occasional
misconduct that occurs with stag affairs. Accordingly, the court held that the
expenses of Mrs. Thomas were deductible or, alternatively, the reimbursement
was not income.
The Court of Appeals did not share the District Court’s opinion. At the
appellate level, the court first explained that the treatment of the expenses by the
company had no bearing on the treatment by the taxpayer. It pointed out that an
all-expense paid vacation trip to Florida may increase the employee’s efficiency
and be a business expense to the employer, but that this did not change the fact
that to the recipient the trip is solely for pleasure and is in the nature of a bonus or
reward.
According to the Fifth Circuit, the crucial issue was determination of whether
the primary purpose of the trip was business or pleasure. In determining the
purpose, the court examined several factors. First, the court focused on the
amount of time spent on personal activity relative to the amount of time spent on
business. In this regard, it was determined that at most five hours out of 31=2
days were spent in formal business meetings. Although the court was somewhat
sympathetic to the taxpayer’s argument that while “playing” he could gain
business insights and improve his abilities as a salesman, other factors suggested
otherwise. For example, the court viewed as unfavorable to the taxpayer the fact
that the meeting was held at a resort. Apparently, this factor, when combined with
the amount of time spent in formal meetings, helped to convince the court that the
purpose of the meeting was pleasure rather than business. Moreover, in reviewing
the company’s attitude toward the meeting, it found that the company looked on
the trip as one primarily devoted to pleasure. For example, company
correspondence indicated that the business was secondary and the main object
was to have a good time. Based on its findings, the Appellate Court believed that
the opinion of the District Court was clearly erroneous and reversed the trial
court’s decision. As a result, the taxpayer was allowed a pro rata deduction for the
amount of time spent at the business meetings, but no deduction was allowed for
his travel expenses because the purpose of the trip was not primarily for business.
In a vigorous dissent, Justice Brown characterized the position of the taxpayer
as that of an “organization man” whose expenses were not a voluntary, but an
involuntary, part of his business. He pointed out that the taxpayer had nothing to
do with picking out the location. Moreover, the taxpayer had no choice over
whether or not to attend. Instead, in Judge Brown’s view it was an obligatory
appearance over which the taxpayer had no control. Thomas was compelled to
take the trip as a matter of business necessity. Apparently Judge Brown’s
argument fell on deaf ears.
The Rudolph case presents a fact situation similar to that of Mr. Thomas. In
this case, the taxpayer sold insurance for Southland Life Insurance Company
located in Dallas. By having sold a predetermined amount of insurance, the
taxpayer qualified to attend the company’s convention in New York City and, in
line with company policy, to bring his wife with him. The taxpayer along with his
wife and others traveled to and from New York by train, and were housed in a
single hotel during their two and one-half day visit. One morning was devoted to
a business meeting and group luncheon, and the rest of the time was spent seeing
New York. The company paid for the trip.
The District Court, with guidance from the Alabama District Court’s decision
in Patterson v. Thomas, examined the facts to determine the primary purpose of
the trip. According to the court, the fact that the convention was held in a remote
place was in and of itself sufficient to cause the trip to be personal. Accordingly,
the taxpayer’s deduction was denied. Upon appeal to the Fifth Circuit, the court
saw no difference between this and the Thomas case and so held. Justice Brown
once again dissented!
The taxpayer in Rudolph was allowed a final review by the Supreme Court. At
this level, the taxpayer initially argued that the reach of §61 defining gross income
did not extend to such trips and consequently the payment should not be taxable.
According to the taxpayer’s view, the trip was a nontaxable fringe benefit. The
Court rejected this view however, noting little more than that the sweeping scope
of § 61 was established in Glenshaw Glass, 55-1 USTC ¶9308. The Court
emphasized the purpose of § 61 was “to include as taxable income any economic
or financial benefit conferred on the employee as compensation, whatever the
form or mode by which it is effected.” The Court appeared to adopt the view that
the trip was in the nature of a reward or bonus given to employees for excellence
in service. Accordingly, given the Court’s belief that the amount was not a
nontaxable fringe benefit but rather taxable income, the remaining question was
whether the taxpayer had an offsetting deduction.
According to the Court, the critical question was whether the purpose of the
trip was related primarily to business or was rather primarily personal in nature.
The taxpayer used Justice Brown’s lines and argued that he was an “entrapped
organization man,” required to attend such conventions and that his future
promotion depended on his presence. The Court did not share the taxpayer’s
opinion, however. Instead, it agreed with the District Court, which found that the
taxpayers regarded the convention as a pleasure trip in the nature of a vacation.
The hard line taken by the courts in the cases above should not be seen as an
impossible hurdle. Other cases have been more receptive to the taxpayer. In
Peoples Life Insurance Co. v. U.S., 67-1 USTC ¶9301 (Ct. Cls., 1967), the court
examined the agenda for the meeting and determined that it was primarily related
to business. Moreover, it found that the taxpayer’s attendance at the meeting was
motivated by business intent and the pleasure seeking activities were not
consequential. Similarly, in U.S. v. John Gotcher, 68-2 USTC ¶9546 (CA-5,
1968), the Fifth Circuit took a different approach. Here the taxpayer and his wife
received an expense paid trip to Germany from Volkswagen and his employer so
that they might tour the factories and facilities and make a decision on a purchase
of a Volkswagen dealership. One of the key factors distinguishing Gotcher from
Patterson and Rudolph was that the trip was in no way an award for past service
by Mr. Gotcher, since he was not an employee of Volkswagen and did nothing to
earn that part of the trip paid by his employer. In addition, the court was
convinced in this case that the agenda related primarily to business and any
sightseeing was inconsequential. Accordingly, Mr. Gotcher was not subject to tax.
As the discussion of the above cases suggests, the ultimate determination
depends on the facts and circumstances of each situation. In the instant case, the
taxpayer may be able to demonstrate to the court that sufficient time was spent on
business activities to convince it that the trip was primarily for business.
5-58 The critical issue to be addressed in this fact situation is whether Large may
properly rely on its accrual method of accounting to defer the warranty income
until that period when it expects to provide the services. Alternatively, even if
Large is required to report the income when received, the situation could still be
partially salvaged if Large can deduct its estimates of the future costs of warranty
work. Unfortunately, it appears from the relevant authority that Large must report
the prepayments currently and it will not be allowed to accelerate the deduction of
future estimated costs.
Sections 446 and 451 provide the ground rules for determining when a
taxpayer reports income. Section 446 provides the general rules governing
methods of accounting, stating that taxable income is computed under the method
of accounting used by the taxpayer in keeping his books. At first glance, it would
appear that this provision would allow Large to defer the income since that is the
method it normally uses. However, §446(b) creates an extremely important
exception, giving the IRS the power to require the taxpayer to use an alternative
method if, in its opinion, the taxpayer’s method does not clearly reflect income.
As explained below, the IRS has used this authority in situations involving
prepaid income to require accrual basis taxpayers to report the income when
received rather than when it is earned.
Section 451 rounds out the statutory authority governing the reporting of
income. Under § 451, “the amount of any item of gross income is included in the
gross income for the taxable year in which received by the taxpayer, unless under
the method of accounting used in computing taxable income, such amount is to be
properly accounted for as of a different period.” Regulation § 1.451-1(a)
elaborates, stating that an accrual basis taxpayer reports income when the all–
events test is satisfied. Specifically, accrual basis taxpayers report income when
all the events have occurred that fix the taxpayer’s right to receive such income
and the amount thereof can be determined with reasonable accuracy. A quick
reading of the all-events test would suggest that Large must report the income
when it is received, given that the rights to such income are fixed and the amounts
are known. However, Reg. § 1.451-5 generally permits the taxpayer to defer
recognition of advance payments for goods until such time when the income is
reported for financial accounting. In Large’s situation, the advance payments are
for future services, and unfortunately, the Regulations are silent on the treatment
of prepayments for services.
The Service has long taken the position that the reporting of prepayments for
services is governed by the claim of right doctrine. Under this doctrine,
established early in the life of the tax law, a taxpayer must report amounts as
income in the year in which they are received and in which such income is not
restricted in use. In other words, earnings received must be included in income if
the taxpayer has an unrestricted claim. The IRS has used this theory consistently
to argue that payments for services to be performed in the future must be reported
by an accrual basis taxpayer when received even though such amounts have not
been earned under traditional financial accounting principles.
In one of the first key decisions involving prepaid service income, the IRS
secured a victory. In Automobile Club of Michigan [57-1 USTC ¶9593, 50 AFTR
1967, 353 U.S. 180 (1957)], the taxpayer provided various automobile-related
services such as road maps and highway repairs to its members who paid annual
dues. The Club reported one-twelfth of the dues as income each month but the
IRS contended that the income should be reported as received. The taxpayer
asserted that reporting the income when received as required by the claim of right
doctrine did not clearly reflect income since the taxpayer was on the accrual
method. Interestingly, the Court appeared to have agreed with this argument.
However, the Court also believed that the taxpayer’s arbitrary allocation
procedure was purely artificial and no better than the method required by the IRS.
Consequently, the Court held that the IRS had not exceeded its authority in
requiring the sums to be reported when received, and consequently, the taxpayer
was denied deferral.
Two years after the Michigan decision, the Second Circuit Court of Appeals
reviewed a similar case and found a different result. In Bressner Radio, Inc. [59-2
USTC ¶9496, 267 F.2d 3 AFTR2d 520 (CA-2, 1959)], the corporation sold
televisions and entered into written contracts to install and service them for 12
months. Bressner’s experience showed that an average of 8 to 12 service calls
would be made during the term of the contract. Therefore, Bressner treated 25
percent of the contract price as revenue at the time when the contract amounts
were received. The Second Circuit found this method of accounting did clearly
reflect income. It interpreted the Supreme Court’s decision in Michigan as
allowing deferral if the method was not artificial but realistic. After Bressner, it
appeared that taxpayers who were able to establish that their method of allocating
income was not merely arbitrary or capricious might be able to defer prepaid
service income. However, the Service quickly denounced this approach in Rev.
Rul. 60-85, ruling that prepaid service income that was received under a claim of
right and without restriction as to its disposition had to be reported as income in
the year received. According to the ruling, this approach applied regardless of
whether the period of proration was definite (as in Automobile Club) or indefinite.
As one might expect, the Service did not relent.
The Supreme Court examined the issue again in 1961 and 1963. In the first
case, American Automobile Association (AAA) [61-2 USTC ¶9517, 7 AFTR2d
1618, 367 U.S. 687 (USSC, 1961)] the facts were virtually identical to Michigan
except in AAA the taxpayer presented “expert accounting testimony indicating that
the system used was in accord with generally accepted accounting principles; that
its proof of cost of member service was detailed; and that the correlation between
that cost and the period of time over which the dues were credited as income was
shown and justified by proof or experience.” Relying on this testimony, the
taxpayer argued that it had demonstrated that its method of ratable deferral was
not artificial. The Court of Claims rejected this argument and the Supreme Court,
recognizing a conflict between Bressner and AAA decisions, granted certiorari.
The Supreme Court upheld the Court of Claims decision, emphasizing that
substantially all services were performed on demand and the taxpayer’s
performance was not related to fixed dates after the tax year. The Court
ambiguously dealt with the taxpayer’s argument that statistical computations
provided a rational approach for deferral. Consequently, some taxpayers as
evidenced by the litigation that followed believed that deferral might be allowed if
they could adequately demonstrate when the service income would be earned.
Indeed, shortly after the AAA decision, the Second Circuit noted that its view in
Bressner was still valid [Automobile Club of New York 62-2 USTC ¶9567, 10
AFTR2d 5001, 304 F.2d 781 (CA-2, 1962)]. In that case, the court allowed
deferral which was based on the taxpayer’s statistics, showing a “definite monthly
business experience and financial expectancy.”
The Supreme Court’s third look at the prepayment issue occurred in Schlude
[63-1 USTC ¶9284, 11 AFTR2d 756, 372 U.S. 128 (USSC 1963)]. The taxpayers
in Schlude operated dance studios and sold contracts for a specified number of
hours of dance lessons, ranging from five to 1,200. The contracts specified the
period during which the lessons had to be taken but the actual dates of lessons
were arranged from time to time as they were taken. When the taxpayer received
the prepayments, a deferred income account was set up. Then, at the end of each
period, income was reported based on the number of lessons completed to date. In
certain cases, such as when there had been no activity in an account for a year, the
entire amount of the deferred income would be reported. The Third Circuit
initially upheld the taxpayer’s view, prior to the Supreme Court’s decision in AAA.
On appeal, the Supreme Court (having issued its decision in AAA), remanded the
case back to the Third Circuit, which reversed its original decision. However, the
Supreme Court decided to look at the Third Circuit’s decision “to consider
whether the lower court misapprehended the scope of AAA. Although the
Supreme Court did affirm the Third Circuit’s holding for the taxpayer, the fact
that it reviewed the decision suggested to at least some that the AAA holding was
as broad as perhaps some had thought. The lingering doubt left by the trilogy of
Supreme Court cases offered hope to taxpayers who were willing to test the IRS.
For example, in Artnell [68-2 USTC {9593, 22 AFTR2d 5590, 400 F.2d 981 (CA-
7, 1968)], the taxpayer was able to establish with the necessary accuracy when the
prepaid income would be earned and the court permitted deferral. In that case, the
Chicago White Sox baseball organization was able to show that amounts received
for season tickets prior to the end of their fiscal year (May 31) would be earned as
each game was played over the balance of the season. In distinguishing the case
from AAA, the Seventh Circuit noted that the date when the services would be
provided was fixed and the services would not be provided on demand.
It was not long after Artnell, that the IRS relented somewhat. In Rev. Proc. 71-
21, 1971-2 C.B. 549, the Service allowed accrual basis taxpayers to defer the
recognition of prepaid income from services if such services were performed in
the year following the year in which the advance payment was received.
However, § 3.08 of this Rev. Proc. specifically denies such treatment for warranty
income. Consequently, the IRS adhered to its view that warranty income was
taxable in the year received.
Perhaps the most significant development since the three Supreme Court cases
occurred in RCA Corp. v. U.S. [81-2 USTC ¶9783, 664 F.2d 881 (CA-2, 1981)
reversing 80-2 USTC ¶9622 (D.C., NY, 1980)]. Interestingly, this case ultimately
came before the Second Circuit that had previously rejected a broad reading of
AAA. RCA, an accrual basis taxpayer, contracted with purchasers of its products to
provide service and repairs for a stated period in exchange for prepayment of a
single lump sum amount. Under the contract, the services were provided on
demand at any time during the term of the contract. RCA did not report the
income when received. Instead, it deferred the income until that period when it
expected to provide the services, a method which was in acceptance with
generally accepted accounting principles. The postponement of income to a
particular period was based on forecasts developed using sophisticated statistical
methods. Perhaps following the lead of the Second Circuit, the District Court
agreed with the taxpayer. According to the District Court, it felt that the language
used in AAA was far from clear. The Court believed that a taxpayer was entitled to
rely on reliable statistical projections of anticipated expenses in determining the
extent to which prepaid amounts should be included in gross income. Moreover, it
emphasized that the IRS could not reject a deferral method of accounting simply
because the deferred revenues related to services to be performed at unspecified
times in subsequent tax years. The Court also rejected a second government
argument that the IRS could reject any method of accounting that deferred the
inclusion of prepaid income, unless authorized by statute. In so doing, the Court
noted that the Code specifically allows the accrual method of accounting.
According to the Court, the ultimate question was simply whether the taxpayer’s
method of accounting clearly reflected income.
Although the District Court decision in RCA seemed well-reasoned, the
Second Circuit surprisingly reversed it and thereby rejected its previous position.
The Court began its assault on the lower court’s decision citing Thor Power Tool
and noted the vastly different objectives of financial and tax accounting. It noted
that the District Court gave too little weight to the objectives of tax accounting
and to the Commissioner’s wide discretion in implementing those objectives.
Moreover, it emphasized that it was the reviewing court’s job not to determine
whether a taxpayer’s method of accounting clearly reflected income but whether
there was adequate basis in law for the Commissioner’s conclusion that it did not.
Thus, it proceeded to examine whether the IRS had abused its discretion.
Relying on the Supreme Court’s decision in AAA and Schlude, the court
stated that:
… when a taxpayer receives income in the form of prepayments in respect of
services to be performed in the future upon demand, it is impossible for the
taxpayer to know, at the outset of the contract the amount of service that his
customer will ultimately require, and, consequently, it is impossible for the
taxpayer to predict with certainty the amount of net income …
The Court concluded that warranty income was income in the year of receipt, and,
just as important, the IRS did not abuse its discretion in rejecting the RCA’s
method of accounting.
An alternative approach that the taxpayer might consider concerns
acceleration of the deduction for estimated costs of the warranty work to the
period in which the warranty income was recognized. As a general rule, an
accrual basis taxpayer may deduct expenses if the all-events test is satisfied, that
is, the obligation is fixed and the amount can be determined with reasonable
accuracy. Although Large could arguably deduct its estimated cost under this
basic rule, § 461(h) adds an additional requirement. No deduction can be accrued
until economic performance occurs. In the case of services, economic
performance occurs when the taxpayer provides the services. Consequently, §
461(h) eliminates any hope of accelerating the deduction for estimated warranty
costs.
5-59 RT Haulers is an accrual basis taxpayer with a December 31 tax year-end. RT
provides delivery services to a variety of customers. Under the current terms of
these agreements, RT’s customers cannot reject RT’s performance of services
without penalty or obligation. However, RT proposes changing its agreements
with its customers to provide for a seven-day acceptance period after performance
of transportation services in which the customers can reject the performance of
any services without penalty or any obligation (the “seven-day acceptance
period”). RT has requested guidance regarding how the proposed change in terms,
specifically the offer of a seven-day acceptance period, will affect the Federal
income tax treatments of service revenues.
As a general rule, under the accrual method of accounting, income is
recognized for Federal income tax purposes when (1) all events have occurred
that fix the right to receive such income, and (2) the amount can be determined
with reasonable accuracy. Under this so-called “all events test,” it is the fixed
right to receive the income that is controlling and not whether there has been
actual receipt of income.
In the seminal case of U.S. v. General Dynamics2, the U.S. Supreme Court
considered the so-called “all events test” in the context of determining when
expenses for services may be deducted. The court stated that “[i]t is fundamental
to the ‘all events test’ that, although expenses may be deductible before they
become due and payable, liability must first be established.” (Italic added.) This
statement is critical because, although the Court in General Dynamics was
addressing the application of the “all events test” for purposes of the timing of
deductions, the same “all events test” considered in General Dynamics applies to
the timing of income recognition3, Therefore, based upon the Court’s reasoning in
General Dynamics, it is appropriate to conclude that although income may be
recognized for Federal tax purposes before it becomes due and payable, the pay
or’s liability must first be firmly established in order for income to be recognized.
1 Charles Schwab v. Commissioner, 107 TC 282 (1996), aff’d 161 F.3d 1231 (9th Cir.
1998), cert. denied 120S.Ct. 67 (1999).
2 481 U.S. 239(1987).
3 Compare Treasury regulations § 1.446-1 (c)(1)(ii); § 1.451-1 (a); and §
1.461.1(a)(2)(I). See also Revenue Ruling 98-39 and citations therein, including
Schneer, infra.
In General Dynamics, the taxpayer argued that it was entitled to deduct
certain employee medical expenses where the medical services had been
performed, but for which the employee had not yet submitted a request for
reimbursement to the taxpayer. The Supreme Court found that the employees’
submissions of claims for reimbursement, and not the performance of services,
gave rise to the taxpayer’s legal obligation to make payment. Thus, the Supreme
Court held that the taxpayer could not deduct employee medical expenses where
the services had been performed but for which the employees had not filed claims
for reimbursement. The Supreme Court observed, “[i]t is fundamental to the ‘all
events’ test that, although expenses may be deductible before they have become
due and payable, liability must first be firmly established.”
The General Dynamics decision is important in analyzing when the all events
test requires revenue recognition for revenues generated by the provision of
services. In General Dynamics, the all events test was not met until some time
after the underlying services had been performed. That is, the all events test was
not met until the legal obligation to make payment arose, even though the
underlying performance of services had already occurred. The Supreme Court
considered the importance of the timing of the performance of services for
purposes of the all events test and observed, “[m]ere receipt of services for which,
in some instances, claims will not be submitted does not, in our judgment,
constitute the last link in the chain of events creating liability for purposes of the
‘all events’ test.” Although the Supreme Court in General Dynamics considered
the all events test in the context of the timing of deductions, the same all events
test applies to the timing of revenue recognition. 4Thus, General Dynamics
directly supports the proposition that the all events test does not require the
recognition of services revenue until the legal right to receive payment for such
services arises—even though the legal right arises after the performance of the
services.5
Several Tax Court decisions have considered the application of the all events
test for purposes of recognizing service revenue. In Schneer v. Commissioner6 ,
the Tax Court considered the timing of recognition of income derived from the
performance of services. The Tax Court cited the general rule that “[i]ncome is
said to accrue where the right to receive it becomes fixed, that is when there is an
enforceable liability.” The Tax Court added: “The right to receive income cannot
become fixed before the obligor has an obligation to pay.” Further, the Tax Court
offered the following example: “Under the accrual method, income may not be
subject to taxation at a time when payment remains subject to the discretion of the
employer, or there is some other factor of uncertainty.” (Citations omitted.)
More recently, in Charles Schwab v. Commissioner7 , the Tax Court
considered when a securities broker recognized commission income, at the trade
date (i.e., at the time substantial performance had been completed) or at the
settlement date (i.e., at the time all performance was complete). The taxpayer
argued that, under the all events test, its performance was not complete until the
settlement date. The government argued, and the Tax Court held, that the
taxpayer’s performance was complete at the time the taxpayer traded the security
for the customer because performance of the trade was the essential service that
the taxpayer performed and was the time at which the taxpayer’s right to receive,
and the customer’s obligation to pay, the taxpayer’s commission arose.
The Tax Court cited the U.S. Supreme Court case of Schlude v.
Commissioner8, for the standard for income recognition and, in particular,
recognition of income derived from the provision of services: “The taxpayer’s
right to receive income is fixed upon the earliest of (1) the taxpayer’s receipt of
payment, (2) the contractual due date, or (3) the taxpayer’s performance.” The Tax
Court’s use of the Schlude standard is significant because it include “the
performance of services” as one of the events that fixes the right to income. This
is somewhat contrary to the proposition of General Dynamics that the
performance of services is not necessarily an event that fixes that right to income.
These two seemingly divergent propositions can be reconciled if we assume that
the performance event set forth by the Schwab court is complete only after the
liability to make payment for the performance arises. This reconciling
interpretation is supported by the court’s analysis in Schwab.
The Tax Court in Schwab clearly based its holding against the taxpayer on the
fact that the taxpayer’s right to the income arose at the time of the trade, not at the
subsequent time of settlement. For example, in support of its conclusion, the Tax
Court noted:
4 See footnote 2
5 See also Hansen v. Commissioner, 360 U.S. 446 (1959), in which the Supreme Court
considered a case where the taxpayer did not have a present right to compel payment
from customers, but did, nonetheless, have an enforceable right to recover payments.
The Court noted that income is not recognized for tax purposes at the point in time
when taxpayers can presently compel payment but, rather, at that time when taxpayers
can compel payment (presently or at some future point).
6 97 T.C. 643 (1991).
7 107 T.C. 282 (1996), aff’d 161 F.3d 1231 (9th Cir. 1998).
8 372 U.S. 128, 133, 137(1963).
If petitioner does not receive payment on a purchase or sale order executed for
the customer, it liquidates the customer’s account to collect the amount,
including the commission, determined on the trade date. Upon execution of a
customer order, a written confirmation is generated automatically and is sent
to the customer on the next business day following the trade date. The written
confirmation serves as an invoice and as written notification to the customer
of the trade. The confirmation statement itemizes the total cost of the trade,
including the amount of the commission, and lists the total “amount due.”
Petitioner encloses a remittance stub and a return envelope with the
confirmation. The customer does not have the right to cancel an order that
petitioner executes in accordance with the instructions of the customer… We
think the above facts indicate that petitioner’s execution of a trade… fixes
petitioner’s right to receive the commission income. (Italic added.)
Thus, it seems clear that the Tax Court in Schwab decided against the taxpayer,
and held that income must be recognized as of the trade date, because the
taxpayer’s customers did not have the right to cancel any obligations to pay for the
taxpayer’s service after the trade date.
It is also seems clear from the Tax Court’s discussion of the Hallmark case
that the Tax Court would have applied Hallmark in favor of the taxpayer, and
allowed the taxpayer to defer recognition of income derived from services until
the settlement date, if the taxpayer’s right to payment from its customers did not
arise until the settlement date. This conclusion is supported by the following
discussion of the Hallmark case by the Tax Court in Schwab:
Petitioner argues that this case is governed by Hallmark Cards, Inc. v.
Commissioner, 90 T.C. 26 (1988). In Hallmark, a manufacturer and seller of
greeting cards shipped its Valentine merchandise to customers in the year
prior to that in which the holiday occurred. The terms of the sale specified that
title and risk of loss did not pass to the customer until January 1 of the year
following the shipment. This Court held that the taxpayer’s right to income
from the sale became fixed only upon passage of title and risk of loss to the
purchasers, notwithstanding that delivery of the goods had occurred earlier.
Id. At 32-22. Petitioner argues that because title to the securities does not pass,
and petitioner is not relieved of its risk of loss until the settlement date, its
right to the commission income is not fixed until the settlement date.
Hallmark v. Commissioner, supra., is distinguishable from the instant case. In
Hallmark, the taxpayer was a manufacturer and seller of goods. Thus, passage of
title and risk of loss constituted the essence of the transaction; without such
passage, no sale occurred. Conversely, the present case involves a service
provider that executes securities trades as an agent of its customers. We think that
the focus in this case must be on the contractual relationship between petitioner
and its customer, not on the relationship between the customer and purchaser or
seller of the securities. The agreement between petitioner and its customers was
that any trade executed by petitioner in accordance with the customer in
Hallmark had the right to return the merchandise without penalty until title
passed. Id. At 33. The essence of the transaction between petitioner and its
customer is the execution of a trade on behalf of the customer. (Italic added.)
Thus, Tax Court in Schwab relied heavily on its analysis in Hallmark to
support its holding that the taxpayer could not defer the recognition of income
beyond the point in time when its customers became legally obligated to make
payment for services.
Finally, the Tax Court in Schwab distinguished between conditions precedent,
which must occur before the right to income arises, and conditions subsequent,
the occurrence of which will terminate an existing right to income (i.e., a right
created by a condition precedent), but the presence of which does not preclude the
accrual of income for Federal tax purposes. However, it is important to note that,
by definition, a condition precedent creates an obligation to make payment. Thus,
although a condition subsequent does not prevent the recognition of income until
after an obligation is created (i.e., after a condition precedent), there is no
recognition of income in the first place unless and until there is an initial
obligation.
Perhaps the most cogent and compelling description of the importance of the
existence of a legal obligation in determining whether the all events test requires
the recognition of include can be found in the Tax Court case of Hallmark Cards
v. Commissioner9.
9 90 T.C. 26(1988).
In Hallmark, the Tax Court considered when income from sales of
merchandise should be recognized for tax purposes and held that the “all events
test” was not satisfied until title and risk of loss to the merchandise passed to the
customer. The Tax Court noted: “The objective is to determine at what point in
time the seller acquired an unconditional right to receive payment under the
contract.” The Tax Court went on to find that the taxpayer had no right to receive
income prior to the passage of title and risk of loss to the customer. In support of
its holding, the Tax Court cited General Dynamics for the proposition:
Here … petitioner does not possess any fixed and definite rights to payment at
year-end. The fact that at the stroke of midnight petitioner knows with
absolute certainty that in the next instant these rights will arise cannot
compensate for the fact that as of the close of the old tax year they do not
exist. The all events test is based on the existence or non-existence of legal
rights or obligations at the close of a particular accounting period, not on the
probability—or even absolute certainty—that such right or obligation will
arise at some point in the future.10
Thus, although Hallmark involved the application of the all events test for
recognizing income from the sale of goods, rather than services, the Tax Court’s
language in Hallmark resonates and articulates the conclusion of General
Dynamics, which pertained to services, that income cannot be recognized unless
the taxpayer’s customer has some obligation to make payment or, conversely, the
taxpayer has some right to payment. The fact that Hallmark relies on General
Dynamics clearly supports the application of Hallmark to situations involving the
provision of services in addition to the dale of goods.
Finally, by providing for a seven-day acceptance period in which customers
can reject services already performed without obligation, Taxpayer is at genuine
economic risk. For example, Taxpayer must consider how the seven-day
acceptance period provision will affect the collectibility of disputed receivables.
The economic cost and risk of the acceptance period is the marginal increase in
non-collectible receivables caused by the seven-day acceptance provision.
However, it is likely that the collectibility of many of Taxpayer’s receivables will
not be affected by the seven-day acceptance period. The economic cost of the
acceptance period provision should be based only on those receivables that, but
for the seven-day no obligation acceptance period, would have been collectible
and actually collected.
The real risk of economic loss is the price Taxpayer pays for any tax deferral,
and could conceivably exceed any tax deferral benefits resulting from the change
in business terms. This real economic risk and potential cost gives the seven-day
acceptance period economic substance. This economic substance may prevent, or
at least mitigate, a government challenge of the proposed tax treatment of the
seven-day acceptance period based on a form-over-substance argument.
Based on the legal authorities discussed above, in most circumstances11,
income derived from the provision of services must be recognized for Federal tax
no earlier than when the recipient of those services becomes obligated to make
payment for such services.
Under Taxpayer’s current terms, customers cannot reject performance of
services within seven days of performance without penalty or obligation. Thus,
Taxpayer’s performance presumably creates some legal obligation for the
customer to make payment for the services performed. Thus, income must be
recognized when services are completed.
However, if the Taxpayer adopts a seven-day “no obligation” acceptance
period commencing after services have been completed and during which
customers have absolutely no legal obligation to make payment for services if
they choose to reject such services within the seven-day acceptance period, it
appears more likely than not that Taxpayer will not have to recognize income for
Federal income tax purposes until the lapse of the seven-day acceptance period.
5-60 This research question examines the treatment of reimbursements as income. As
discussed in detail in Chapter 8, reimbursements paid pursuant to an accountable
plan as defined in § 62(a)(2)(A) can be excluded by the employee and, perhaps
more importantly, are not subject to employment taxes. On the other hand, if the
payments are not paid pursuant to an accountable plan, the reimbursements are
included in the employee’s wages, are subject to employment taxes and the
employee deducts the expenses as miscellaneous itemized deductions subject to
the 2% limitation. Obviously, the difference in treatment is quite dramatic,
particularly with respect to the employment tax obligation of the employer.
The problem facing the taxpayer in this situation is similar to that found in
Trucks Inc. v. U.S., 80 AFTR 2d 97-6625, (District Court of the Northern District
of Georgia, 1997). In Trucks, the corporation was denied a refund of withholding
taxes paid on expense reimbursements issued to over-the-road drivers. According
to the court the reimbursements were not paid pursuant to accountable plan as
discussed in Chapter 8 (§ 62(a)(2)(A)). Therefore the amounts should have been
treated as wages included in the W-2s of the employees subject to withholding
and employment taxes. Interestingly, for the years at issue, Trucks excluded from
wages payments that totaled over $1.3 million for 1991, over $2.2 million in
1992, and over $3.4 for 1993.
10 Also citing Decision, Inc. v. Commissioner, 47 T.C. 58 (1966) and Cox v.
Commissioner, 43 T.C. 448 (1965).
11 Of course, this conclusion does not apply if the taxpayer recognizes income on the
percentage-of-completion (PCM) method. Further, there is not benefit if the taxpayer is
a cash basis taxpayer.
The court explained that while there was little doubt that the drivers would
incur the meals and lodging expenses in connection with services performed for
the corporation, the expense arrangement did not meet the technical requirements
set forth in the applicable provisions. There was no per diem arrangement.
Moreover, there was no per diem arrangement that met the applicable
requirements. The employer merely stated that a certain percentage of the
taxpayer’s compensation was for these expenses. Drivers were not required to
substantiate their expenses. While substantiation is not required where there is a
qualified per diem arrangement, no formal per diem arrangement existed. Drivers
received the same flat rate regardless of whether they paid for lodging or slept in
their trucks. The drivers’ trip sheets and time logs did not include lodging; and
Trucks did not substantiate expenses with receipts or driver testimony.
Based on this case, the taxpayer should be advised to restructure their
reimbursement arrangement to meet the standards set for a qualified accountable
plan.
5
Gross Income
Test Bank
True or False
________ 1. The economist’s definition of income is expressed mathematically as the
sum of one’s consumption during a period plus the change in one’s net
worth between the beginning and end of the period. Consumption and
the change in net worth are measured using market values on an accrual
basis.
________ 2. Economists recognize income once it has been realized: (1) the earnings
process is complete, and (2) an exchange or transaction has taken place.
________ 3. As a general rule, all income is taxable unless you can locate authority to
exclude it from gross income.
________ 4. MNO Corporation sued XYZ Incorporated for patent infringement and
was awarded $100,000 damages. The $100,000 is taxable.
________ 5. B was recently fired from her position as newscaster for NBS, a national
television network. She sued the network for lost wages on the grounds
that she was improperly fired. Ms. B won the case and was awarded
$25,000. She must treat the $25,000 as taxable income.
________ 6. G was injured in a car wreck. He sued the driver of the other automobile
and was awarded $10,000 for personal injury. In addition, he was
awarded $3,000 as punitive damages. G must report $3,000 as income.
________ 7. Video Games Unlimited Inc. allows its game designers to use, without
charge, company cars for their personal vacations. The employer’s
motive for providing the cars is to ensure that these valuable assets (i.e.,
the employees) of the business are retained. Because this is a reasonable
business purpose, the employees will recognize no income from their use
of the cars.
________ 8. An S corporation is similar to a partnership in that shareholders, like
partners, are not taxed on the income of the entity until it is distributed to
them.
________ 9. A taxpayer who reports in conformity with generally accepted
accounting principles (GAAP) satisfies the tax requirement that income
must be clearly reflected. For these taxpayers, book income and taxable
income will not vary.
________ 10. Near year-end, FGH Construction Corporation mailed E, a plumbing
contractor, a $10,000 check for services that he had performed on one of
the corporation’s projects. On December 27 of this year, the controller of
FGH called E and asked E not to cash the check until after the first of the
year, because there were insufficient funds in the bank to cover it. E
must include the $10,000 as income this year.
________ 11. Under the cash equivalent doctrine, the taxpayer reports income from
credit sales.
________ 12. Upon graduation, T signed a contract to play professional football. The
contract contains the team’s unsecured promise to pay T $500,000,
$200,000 to be paid in his rookie year, with the remaining $300,000
deferred over the next three years. Assuming all other requirements are
satisfied, the constructive receipt doctrine would require inclusion of the
full $500,000 in income this year, since T was able to control the timing
of receipt through a contractual arrangement.
________ 13. Healthy Pools Incorporated, an S corporation, operates a swimming pool
business. It has successfully acquired many of the hotels and motels in
the area as customers. It bills monthly for its services. Assuming the
corporation wishes to use the accrual method to account for its billings,
it must also use the accrual method to account for all other receipts and
disbursements.
________ 14. Clean Wheels, Inc., a calendar year taxpayer, operates a car wash that is
located two blocks from six car dealerships that use the facility regularly.
Clean has set up credit arrangements with each of the dealerships to
allow them to use the car wash and be billed for the services at the end of
the month. During the month of December, Clean billed the dealerships
$3,000 for the car wash services. These bills were paid in January. Clean
must accrue and report the $3,000 as income in December.
________ 15. Crash Corporation manufactures hard disk drives for computers. Its
gross receipts for the past several years have averaged less than $2
million. The corporation may use the cash method to account for all of
its receipts and disbursements.
________ 16. A public accounting firm that operates as a professional corporation and
has $10 million in gross receipts may use the cash method.
________ 17. There are no special tax consequences arising from a change in
accounting method as long as the taxpayer is switching from one
permissible method to another.
________ 18. T owns a series EE savings bond. In previous years, he elected to report
the interest income from the bond (i.e., the annual increase in redemption
value) when he redeemed the bond rather than currently. This year, T
decided that he would be better off to report the income annually rather
than defer it. To accomplish this objective, T must seek the approval of
the IRS.
________ 19. Last year, J started his own men’s clothing store business. His small
operation did not warrant a sophisticated accounting system.
Consequently, he simply kept track of all his receipts and disbursements
in a checkbook for the business. When he files his return, he indicated
that he used the cash method of accounting. This year he wants to
change to the accrual method of accounting in order to more clearly
reflect income. J may change to the accrual method without consent
because he is changing from an erroneous method to a correct method.
________ 20. Several years ago, T started an automotive repair business. His small
operation did not warrant a sophisticated accounting system.
Consequently, he simply kept track of all his receipts and disbursements
in a checkbook for the business. When he filed his return, he indicated
that he used the cash method of accounting. This year he wants to
change to the accrual method of accounting. J may change to the accrual
method without consent because he is changing to an accounting method
that more clearly reflects income.
________ 21. C is the controller of XYZ Corporation. As C prepared this year’s tax
return, she noted that several errors had been made in posting the
accounts in the prior year and were reflected on last year’s tax return. To
correct the errors in the prior year’s return C should seek approval from
the IRS since this is a change in accounting method.
________ 22. G’s accountant recently determined that G should be capitalizing certain
costs that he has traditionally expensed. According to the accountant, G
is using a clearly erroneous method of accounting. A change to the
proper method would result in substantial income in the year of the
change. G should consider voluntarily making the change to the proper
method because the treatment is more favorable than if the IRS requires
the change.
________ 23. R currently operates a hardware store and uses the cash method of
accounting for all income and expenses. Under the general rules, R may
use the cash method.
________ 24. L currently reports income from Series EE savings bonds annually. He is
considering switching to the alternative method. L may change methods
without consent from the IRS.
________ 25. Embezzlement proceeds are not taxable because the embezzler has an
obligation to repay the funds.
________ 26. S, a cash basis taxpayer, received a $10,000 prepayment for services that
he contracted to perform in the following year. S may report the income
in the following year when he earns it.
________ 27. Heat-a-Home, an accrual basis calendar year taxpayer, sells furnaces.
With each sale, the corporation also sells a one-, two-, or three-year
contract to turn the furnaces on and off and do routine maintenance.
Assuming the corporation sold a two-year contract on November 1 at a
price of $240, it may report income for this year of $20.
________ 28. Warm-a-Home, an accrual basis calendar year taxpayer, sells furnaces.
With each sale, the corporation also sells a one-, two-, or three-year
contract to turn the furnaces on and off and do routine maintenance.
Assuming the corporation sold a one-year contract on November 1 at a
price of $120, it will report income for this year of $20.
________ 29. Cool-a-House, an accrual basis calendar year taxpayer, sells air
conditioning units. With each sale, the corporation also sells a one-, two-
, or three-year contract to turn the units on and off and do routine
maintenance. In determining its reporting options, the taxpayer wants to
postpone recognition of income for as long as possible. Assuming the
corporation sold a three-year contract on November 1 at a price $240, it
will recognize income as it is earned, reporting $20 of income this year,
$120 next year and $100 in the final year.
________ 30. An accrual basis taxpayer reports prepaid rent (e.g., payments received
in advance for the use of property where the lessor provides no services)
when it is earned.
________ 31. Absent any special tax treatment, the claim of right doctrine could be
applied to make the following income taxable in 2012:
Payments received during October 2012 by a skiing corporation for
season passes (November, 2012 through April, 2012). The corporation is
on the accrual basis, and its tax year is the calendar year.
________ 32. On May 3 of this year, R called his broker and told him to sell all of R’s
AZ bonds. R had purchased the bonds for $9,500 several years ago. The
bonds have a $10,000 par value, and pay interest at a rate of 10 percent
semiannually on June 30 and December 31. Ten days after his call R
received a check for $11,000. R should report a capital gain on the sale
of $1,500.
________ 33. Income arising from Series EE U.S. Savings Bonds need not be reported
on an annual basis.
________ 34. Airco is a manufacturer of airplanes, specializing in jumbo jets. This
year it signed a contract with Pan World Airlines to supply it with 20
jumbo jets. Each jet takes 15 months to build. The contract is a long-
term contract.
________ 35. H signed a contract on October 1 to manufacture 35,000 folding chairs;
the manufacturer currently has 5,000 in stock and estimates that the
contract will take 14 months to complete. The contract is a long-term
contract.
________ 36. T Corporation signed an agreement with the city of St. Lansberg to
manufacture 50,000 seats for the city’s new baseball stadium. T does not
carry this type of seat in inventory but will custom make the unique seat
to the city’s specifications. Assuming manufacture of the seats is not
complete at the close of T’s taxable year, the contract will be considered
a long-term contract.
________ 37. This year, F Corporation contracted to build an office building that it
anticipates completing in six months. Assuming construction is not
complete at the end of its taxable year, the corporation must use the
percentage of completion method to account for the income from the
contract.
________ 38. This year, G Corporation contracted to build a hotel that it anticipates
completing in 10 months. G Corporation’s annual gross receipts have
historically exceeded $15 million. Assuming construction is not
complete at the end of its taxable year, the corporation must use the
percentage of completion method to account for the income from the
contract.
________ 39. On October 1 of this year, SBX Construction contracted to build the new
Fourth National Bank office tower. The company began work on
October 15 and is expected to finish construction in 30 months. The
company must use the percentage of completion method in accounting
for the contract.
________ 40. During the year, R Corporation entered into a long-term contract to build
a nuclear power plant. The plant will take four years to build. At the
close of the current taxable year, the corporation estimated that it had
completed 8 percent of the contract. The corporation must use the
percentage of completion method and must report 8 percent of the
estimated contract price as income this year.
________ 41. Corporations using the completed contract method are required to pay
interest on the deferred tax upon completion of the contract.
________ 42. In using the percentage of completion method, annual income to be
reported from a contract is determined in part by comparing actual costs
incurred to total estimated costs. If total actual costs are less than that
which were originally estimated, the taxpayer is required to pay the IRS
interest.
________ 43. H and W have one child, S. Several years ago, S’s grandparents indicated
to H and W that they would like to help pay for their grandson’s college
education. To this end, the grandparents purchased Series EE savings
bonds for their grandson in 2012. In 2012, G enrolled at City University
in his hometown. G derives virtually all of his support from his parents.
However, his grandparents cashed in some of the bonds and paid for G’s
tuition, $500. Grandma and grandpa are retired and have income of
$40,000 for the year. A portion of the interest on the bonds should be
nontaxable.
________ 44. Interest-free loans of less than $10,000 can be used without restriction to
shift income.
________ 45. Assume that the present tax system and its progressive rate structure are
replaced by a so-called flat tax method. Under this system, a single rate
would be applied to any type of income regardless of source, and large
exemptions (e.g., $20,000) would be allowed to each taxpayer to
eliminate low-income taxpayers from the tax rolls. One favorable result
of such a system is to completely eliminate the motivation for
arrangements when the sole purpose is to split or shift income to lower
bracket taxpayers.
Multiple Choice
________ 46. Which of the following does not cause a difference between economic
income and income for tax purposes?
a. The realization concept
b. The treatment of benefits derived in kind from consumer durables
c. The convenience of the employer theory
d. The return of capital doctrine
________ 47. The accountant’s concept of income is distinguished from the
economist’s by
a. The principle of accrual
b. The principle of relativity
c. The principle of realization
d. None of the above
________ 48. Arguably, free parking places provided to employees by their employers
might be excluded from taxable income on the grounds that
a. Such items neither satisfy the economic definition of income nor fall
within the definition of the income for tax purposes.
b. Any gain obtained by the employee is secondary or incidental to the
employer’s business purpose that is served by granting such benefit.
c. The value of the benefit obtained by the employee is not
determinable.
d. The benefit obtained by the employee is not in the form of cash.
________ 49. LMN Partnership is owned equally by R and S, calendar year taxpayers.
The partnership reports on a fiscal year ending October 31. During the
calendar year 2010, the partnership earned $1,000 a month. During the
calendar year 2012, the partnership earned $2,000 a month. During 2010
and 2012, R withdrew $300 a month. On his personal return for 2012, R
will report income from the partnership of
a. $1,800
b. $3,500
c. $11,000
d. $12,000
________ 50. In which of the following situations would the taxpayer not be
considered in constructive receipt of income in 2012? Assume that all of
the taxpayers use the cash method of accounting.
a. Al is a self-employed accountant. On December 27, 2012, he
received a check for $2,000 for preparing the November financial
statements of one of his clients. Due to illness, he was unable to
deposit the check until January 5, 2012.
b. Ben entered into a contract to sell his rental property on December 3,
2012. On that date, the down payment, a check for $1,000, was
placed in an escrow account. Ben received the check when the
transaction closed on January 20, 2012.
c. Sugar Ray fought Rocky on December 25, 2012, a Christmas fight
shown on television all over the world. On December 28, the fight
promoters gave Sugar Ray’s agent, Leo Luciani, a check for $5
million representing his prize money for the fight. Leo delivered the
check to Sugar Ray on January 12, 2012.
d. On December 20, 2012, Mr. Big received stock worth $10,000 as a
bonus from the corporation for which he worked. He did not sell the
stock until January 5, 2012.
e. All of the taxpayers above are in constructive receipt of the income
items.
________ 51. Taxpayers must use special accounting methods for inventories if they
are an income producing factor. Which of the following statements is
true?
a. The taxpayer is required to accrue the cost of the inventory but may
report sales when receivables are collected.
b. The taxpayer is required to accrue the cost of the inventory and
accrue the income from sales of the inventory.
c. The taxpayer is required to expense the cost of the inventory and
accrue the income from sales of the inventory.
d. None of the above are correct.
________ 52. Dr. Payne Phull is a cash basis taxpayer. Normally, his patients pay his
fee on the day they see him in the office. For some customers, his office
processes a medical reimbursement claim and bills the insurance
company for the visit. In the current year, his records reveal the
following:
Cash received at time of office visit $70,000
Collections on insurance receivables 88,000
Total accounts receivable, January 1 5,000
Total accounts receivable, December 31 15,000
All of the receivables outstanding at the beginning of the year were
collected during the year. What amount should Dr. Phull report as his
income this year?
a. $70,000
b. $158,000
c. $168,000
d. $173,000
e. Some other amount
________ 53. Which of the following businesses must use the accrual method of
accounting to account for all or a part of its operations?
a. F Gas Corporation, a chain of 10 gas stations owned and operated by
F. The corporation has gross receipts of $3 million annually.
b. The Clinic. This corporation is owned and operated by 80 physicians
who provide a variety of health care services to the citizens of
Houston. Annual billings to insurance companies and patients
monthly exceed $20 million.
c. Whitewater Rafting of Idaho is a partnership owned by B and T.
Gross receipts for the past several years have averaged $100,000.
d. D Drilling, a partnership owned by J and A. The partnership operates
oil drilling rigs all over the world. Annual gross receipts consistently
exceed $8 million.
e. More than one of the above and these are__________.
________ 54. T Corporation manufactures the Banana, a clone of a popular computer.
Its gross receipts for the last several years have averaged $4 million.
Indicate which of the following statements is true with respect to the
method of accounting that T can adopt.
a. The corporation may use the cash method to account for all receipts
and disbursements.
b. The corporation must use the accrual method to account for all
receipts and disbursements.
c. The corporation may use the cash method for some items and the
accrual method for other items as it desires.
d. The corporation may use the cash method for some items but is
required to use the accrual method for other items.
________ 55. The cash method of accounting may not be used by
a. A solely owned personal service corporation in the management
consulting business.
b. An individual engaged as a sole proprietor whose annual gross
receipts for all prior years exceed $10 million.
c. A partnership that has gross receipts of $7 million (and no corporate
shareholders).
d. Both b. and c.
e. All of the above may use the cash method.
________ 56. R, a cash basis taxpayer, wanted to defer income from 2010 to 2012.
Which of the following will serve that purpose?
a. Purchase of a Treasury Bill in November, 2012 that matures in
February, 2012.
b. A signed agreement with his employer that the latter will pay him
part of his 2012 salary in 2012.
c. Delay cashing his last salary check for 2012 until 2012.
d. Both a. and b.
e. Both a. and c.
________ 57. The following entities are not involved in the farming or timber
business; which of them may not use the cash method of accounting?
a. An S corporation with average annual gross receipts of $8 million
b. A partnership with average annual gross receipts of $12 million
c. A regular C corporation with average annual gross receipts of $10
million
d. A regular C corporation with average annual gross receipts of $4
million
e. More than one of the above.
________ 58. M operates a lawn maintenance business. In the past, the business has
used the cash method of accounting. This year, M decided to switch to
the accrual method. At the beginning of the year, M had accounts
receivable of $50,000 and accounts payable of $20,000. Assuming M
requests a change from the cash to the accrual method, the IRS will
require a
a. Net negative adjustment of $30,000
b. Net positive adjustment of $30,000
c. Net negative adjustment of $50,000
d. Net positive adjustment of $50,000
e. None of the above
________ 59. Which of the following statements is true regarding changes in
accounting methods?
a. The treatment of a change in accounting method differs depending
on who initiates the change.
b. Adjustments arising from a voluntary change in accounting method
are generally accounted for in the year of the change.
c. Taxpayers who change from an incorrect method of accounting to a
correct method of accounting are not required to obtain the consent
of the IRS.
d. Corrections due to errors are treated the same as changes in
accounting methods.
________ 60. T is switching accounting methods this year. Which of the following
statements is true?
a. Assuming T initiates the change, any adjustment normally will be
accounted for in the year of the change.
b. Assuming the IRS initiates the change, any adjustment normally will
be accounted for in the year of the change.
c. There are no special tax consequences arising from a change in
accounting method as long as the taxpayer is switching from one
permissible method to another.
d. None of the above
________ 61. Fast-Heat, an accrual basis calendar year taxpayer, sells furnaces. With
each sale, the corporation also sells a one-, two-, or three-year contract to
service the furnace. On November 1 of this year, the corporation sold a
one-year contract for $120 and a two-year contract for $240. The
taxpayer wants to postpone income for as long as possible. Due to these
sales, the corporation will report income for the current year of
a. $360
b. $140
c. $260
d. $40
e. some other amount
________ 62. Ralph, a cash basis taxpayer, owns a five-story office building that he
leases to various tenants. During the year, he signed a three-year lease
with a tenant and received a check of $6,000 for the following:
Rent for November 1, 2012 to October 1, 2012 $5,000
Advance rent for last three months of lease 600
Security deposit (refundable) 400
For the current year, 2012, Ralph must report income of
a. $6,000
b. $5,600
c. $5,000
d. $832
e. some other amount
________ 63. Lynn O’Leeum is an accrual basis calendar year taxpayer. He operates a
flooring company. His accounting records for 2012 reveal the following:
Collections on accounts receivable $405,000
Sales on account to customers 521,000
Rent received on November 1, 2012
for use of part of his warehouse
from November 1, 2012 to April 30, 2012 12,000
Rent received on February 1, 2012 for use of part of his
warehouse for December 2010 and January 2012 4,000
Of the amounts collected on the accounts receivable, $25,000 was for
receivables outstanding at the end of 2009. Lynn will include gross
income for 2010 of
a. $421,000
b. $533,000
c. $535,000
d. $537,000
e. None of the above
________ 64. Inconsistencies between the tax and financial methods of accounting for
advanced payments for goods received by an accrual basis taxpayer
normally do not occur because
a. The goods for which the payment is made are normally on hand at
year end.
b. The payments received are “substantial” (i.e., they exceed the cost of
the goods to be sold).
c. Delivery of the goods normally occurs within a short period after the
payments become substantial.
d. According to the Internal Revenue Code, tax methods of accounting
for advance payments must be in conformity with financial methods
(GAAP).
________ 65. L purchased ten REX Corporation bonds on March 5 for $11,120. The
bonds have a $1,000 par value and pay interest at an annual rate of 10
percent semiannually on January 1 and July 1. On July 1, L received his
first interest check of $1,000. Immediately after he received the interest
payment, which of the following is true?
a. His basis in the bonds is $11,120.
b. His interest income is more than $1,000.
c. His interest income is less than $1,000.
d. His basis in the bonds is more than $11,120.
________ 66. Prepaid interest income
a. Is recognized as income by cash basis taxpayers when it is earned
b. Is recognized as income by accrual basis taxpayers when it is earned
c. Is recognized by accrual basis taxpayers when received
d. None of the above
________ 67. Which statement is true concerning Series E or EE issues of U.S.
Savings Bonds?
a. The bonds may only be redeemed on or after the final maturity date,
at a predetermined price.
b. Interest payments are made semi-annually at the stated rate to the
holder of the bond.
c. No interest payments are made to the holder of the bond.
d. The bonds may be redeemed with a penalty before the final maturity
date.
e. Both a. and d.
________ 68. JKL Corporation is a large construction company with annual gross
receipts, averaging $20 million annually. This year the corporation
signed an agreement to construct a road for $720,000. Total estimated
costs are $600,000. This year the corporation actually incurred costs of
$240,000. For the year, JKL’s gross profit on the contract will be
a. $0
b. $288,000
c. $200,000
d. $48,000
e. None of the above
________ 69. RST Corporation is a large construction company with annual gross
receipts, averaging $20 million annually. Last year, the corporation
signed an agreement to construct a road for $720,000. Total estimated
costs are $600,000. Last year, the corporation actually incurred costs of
$240,000. This year, the corporation completed the contract and incurred
costs of $300,000. For the current year, RST’s gross profit on the
contract will be
a. $48,000
b. $50,000
c. $99,600
d. $132,000
e. None of the above
________ 70. Using the following information, decide for which of the following the
completed contract method may be used. Assume the taxable year is the
calendar year in all cases.
a. A contract to construct a bridge estimated to be completed in 18
months; the contractor has average annual gross receipts of $15
million.
b. A contract signed on October 1 to build the residence of John Smith;
it is estimated that it will take six months to complete the job. The
contractor has gross receipts of $15 million.
c. A contract to construct a highway estimated to be completed in 36
months; the contractor has average annual gross receipts of $9
million.
d. More than one of the above.
________ 71. Which of the following contracts would be considered a long-term
contract?
a. A contract signed on September 1 with the U.S. Army to
manufacture 20 planes estimated to be completed in 15 months (a
single plane takes about one month to complete); the contractor
currently has 12 planes in inventory.
b. A contract to manufacture a telescope custom-made for space flight.
The telescope will be the first of its kind. Estimated time of
manufacturing is eight months.
c. A three-year contract signed by JB Systems to provide the design
work for the space shuttle.
d. More than one of the above.
________ 72. The famous horticultural metaphor involving the fruit and the tree
operates primarily in situations concerning
a. Bunching of income
b. Splitting of income
c. Deferral of income
d. Contested income
________ 73. Tyler T. Tycoon owns various office buildings and warehouses
throughout the city of Dallas. He rents one building to Kate, Saperstein
and Sons, a large department store. The lease is for four years and calls
for a rental of $12,000 a year. Rent is payable in quarterly installments
on March 31, June 30, September 30, and December 31. On May 1,
Tyler transferred all the rights under the lease to his son, Tex. At that
date, the lease had 44 months to run. This year Tex collected $9,000 of
rents. He paid his father the $1,000 rent received for the month of April
during which he was not the owner of the lease. For the year, Tyler will
report rental income of
a. $1,000
b. $3,000
c. $4,000
d. $12,000
e. some other amount
________ 74. In April, 2012, P purchased Series EE bonds at a cost of $5,000. This
year the value of the bonds increased by $100. With respect to the $100
increase,
a. The increase is never taxable.
b. P may report the increase as income this year.
c. P may postpone recognition of the income until the bonds are
redeemed.
d. Either b. or c.
________ 75. The application of Code § 7872 to interest-free or below-market loans
has certain tax consequences for the lender and borrower. They include
a. The borrower may be allowed an itemized deduction for the interest
hypothetically paid to the lender.
b. The lender is not required to report the hypothetical payment as
interest income until the loan is repaid.
c. The borrower treats the hypothetical payment as earned income.
d. The lender is deemed to have made a completed gift of the loan
amount.
________ 76. Code § 7872 concerns interest-free and below-market loans. To restrict
the application of § 7872 to predominantly abusive situations, Congress
carved out several exceptions. They include all of the following, except
a. Gift loans where the balance outstanding during the year does not
exceed $10,000 provided that the borrower purchases taxable
income-producing assets.
b. Loans not in excess of $10,000 made by an employer to an employee
or an independent contractor.
c. Loans not in excess of $10,000 made by a corporation to a
shareholder.
d. Loans not in excess of $10,000 made by a partnership to a partner.
e. Both a. and d.
________ 77. F has a son, C, who earns a $50,000 salary and has $500 interest income.
During 2012 F loaned C $95,000 without interest to purchase a boat.
Assume interest imputed at the IRS rate is $14,000. Which of the
following statements is true about interest deemed earned by F or the
amount of taxable gift remaining after the annual exclusion?
a. F has interest income of $13,000.
b. F is charged with a taxable gift of $13,000.
c. F has no interest income.
d. F is charged with a taxable gift of $1,000.
e. Both c. and d.
________ 78. Which of the following statements is true?
a. Under the community property system, assets owned before marriage
are considered equally owned by each spouse after marriage.
b. Only a few states use the common law property system.
c. Income from separate property is community property in some
community property states.
d. The common law property system denies criminals rights in
property.
________ 79. Section 66 provides that a spouse will be taxed only on the earnings
attributed to his or her personal services during the year if certain
conditions are met. They include
a. The two married individuals do not live in a community property
state at any time.
b. Any transfer of earned income between the spouses does not exceed
half their total gross income.
c. The couple files a joint return.
d. The couple does not file a joint return.
e. Both b. and d.
________ 80. Several useful techniques permit an individual taxpayer to postpone
income recognition. They include all the following, except
a. Like-kind exchanges
b. Installment sales of property
c. Deferred compensation arrangements
d. Income on Treasury bills
e. All of the above permit deferral
________ 81. “Substantial tax benefits await the self-sufficient (e.g., an individual who
can repair his own automobile is better off from a tax perspective than
someone who cannot).” Select the correct comment on this statement.
a. The above statement is valid, since such an individual may barter his
or her services for those of another and pay no tax on the services
furnished to him.
b. The above statement is valid because the concept of taxable income
would exclude the benefit derived from repairing one’s own
automobile.
c. The above statement is valid because the form of benefit principle
enables a taxpayer to exclude gains received in a certain form.
d. The above statement is false—no tax benefits await the self-
sufficient.
5
Gross Income
Solutions to Test Bank
True or False
