Ind.chapter 4

Prentice Hall's Federal Taxation 2013 Individuals, 26e (Pope)

Chapter I4 Gross Income: Exclusions

1) Loan proceeds are taxable in the year received in cash.Answer: FALSEExplanation: There is a binding obligation to repay a loan. No income is realized.Page Ref.: I:4-2Objective: 1

2) Each year a taxpayer must include in gross income the rental value of his or her personal residence.Answer: FALSEExplanation: No income is realized under income tax concepts of income until the home is sold.Page Ref.: I:4-3Objective: 1

3) Upon the sale of property with an adjusted basis, a portion of the selling price equal to the basis in the property is considered a return of capital to the seller and is therefore not taxable.Answer: TRUEPage Ref.: I:4-3Objective: 1

4) Many exclusions exist due to the benevolence of Congress or as a result of the government's attempts to encourage particular social behavior.Answer: TRUEPage Ref.: I:4-4Objective: 2

5) A taxpayer may avoid tax on income by assigning it to another taxpayer.Answer: FALSEExplanation: The assignment of income doctrine prevents shifting of income. The underlying property must be gifted before the income is earned.Page Ref.: I:4-4Objective: 2

6) In general, if a life insurance policy is sold or surrendered for a lump sum before the death of the insured, the amount received is taxable to the extent it exceeds the premiums paid.Answer: TRUEPage Ref.: I:4-6Objective: 2

7) Accelerated death benefits received by a terminally ill person may be excluded from taxable income.Answer: TRUEPage Ref.: I:4-6Objective: 2

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8) An individual is considered terminally ill for tax purposes if a physician certifies that he is reasonably likely to die within 36 months.Answer: FALSEExplanation: The time period is 24 months.Page Ref.: I:4-6Objective: 2

9) Dividends on life insurance policies are generally excludable income because they are considered a return of premium.Answer: TRUEPage Ref.: I:4-6Objective: 2

10) Sam received a scholarship for room and board. This scholarship is excludable from income.Answer: FALSEExplanation: Scholarship proceeds are excludable only to the extent used for tuition and fees, books, supplies, and equipment.Page Ref.: I:4-7Objective: 2

11) Amounts withdrawn from Qualified Tuition Plans are tax-free if the amounts are used for qualified higher education expenses including tuition, fees, books, and room and board for students attending on at least a half-time basis.Answer: TRUEPage Ref.: I:4-8Objective: 2

12) Any distribution of income from a Qualified Tuition Plan not used for qualified higher education expenses is both included in income and subject to a 10% penalty.Answer: TRUEPage Ref.: I:4-8Objective: 2

13) While payments received because a person has been physically injured are excluded from gross income, payments on account of non-physical injury must be included in gross income.Answer: TRUEPage Ref.: I:4-8 and I:4-9Objective: 2

14) Awards for emotional distress attributable to a physical injury are excluded from gross income.Answer: TRUEPage Ref.: I:4-9Objective: 2

15) Punitive damages are taxable unless they are awarded for physical injuries.Answer: FALSEExplanation: Punitive damages are always taxable.Page Ref.: I:4-9Objective: 2

16) Amounts collected under accident and health insurance policies purchased by the taxpayer are excludable from income.Answer: TRUEPage Ref.: I:4-9Objective: 2


17) Katie, a self-employed CPA, purchased an accident & disability insurance policy. As the result of an auto accident, Katie was unable to work and received $500 of disability benefits per month for seven months. The benefits were based on her estimated monthly income and should be reported as gross income.Answer: FALSEExplanation: The amounts received are not taxable even though the payments are a substitute for wages lost due to illness. The insurance policy was purchased by the taxpayer.Page Ref.: I:4-9; Example I:4-17Objective: 2

18) John, an employee of a manufacturing company, suffered a heart attack and was unable to work for six months. He received $1,500 per month of disability benefits as a result of an employer-provided group policy. The benefits are includible in John's gross income.Answer: TRUEExplanation: Employer-funded disability benefits are taxable.Page Ref.: I:4-9; Example I:4-18Objective: 2

19) Payments received from a workers' compensation plan are taxable.Answer: FALSEExplanation: A statutory exclusion applies.Page Ref.: I:4-10Objective: 2

20) Premiums paid by an employer for employee disability coverage are excluded from the employee's gross income.Answer: TRUEPage Ref.: I:4-11; Topic Review I:4-1Objective: 2

21) The value of health, accident, and disability insurance premiums paid by an employer are generally not included in an employee's gross income.Answer: TRUEPage Ref.: I:4-11; Topic Review I:4-1Objective: 2

22) Mattie has group term life insurance coverage of $120,000 provided by her employer on a nondiscriminatory basis. She must include premiums for $120,000 coverage in gross income using IRS tables.Answer: FALSEExplanation: She will have income imputed for the portion of the coverage in excess of $50,000.Page Ref.: I:4-11 and I:4-12Objective: 2

23) "Working condition fringe benefits," such as memberships in professional organizations paid for by the employer, are generally excluded from the employee's gross income.Answer: TRUEPage Ref.: I:4-13 and I:4-14; Topic Review I:4-2Objective: 2

24) Nondiscrimination requirements do not apply to working condition fringe benefits.Answer: TRUEPage Ref.: I:4-13 and I:4-14; Topic Review I:4-2Objective: 2


25) The exclusion for employee discounts on services is limited to 30% of the price charged regular customers.Answer: FALSEExplanation: The discount on services is limited to 20%.Page Ref.: I:4-13 and I:4-14; Topic Review I:4-2Objective: 2

26) "No additional cost" benefits are excluded from an employee's gross income if the services are the same type that are sold to customers and in the line of business in which the employee works.Answer: TRUEPage Ref.: I:4-13 and I:4-14; Topic Review I:4-2Objective: 2

27) Martina, who has been employed by the Smythe Corporation for ten years, receives a $400 watch as a length of service award in a meaningful presentation. The fair value of the watch is taxable.Answer: FALSEExplanation: The watch is a tangible award for length of service and not in excess of $400.Page Ref.: I:4-14Objective: 2

28) Jeff, who has been employed by the Peach Corporation for twelve years, receives $400 cash for his years of hard work. The cash award is taxable.Answer: TRUEPage Ref.: I:4-14Objective: 2

29) Meals may be excluded from an employee's gross income provided they are furnished on the employer's business premises and are for the convenience of the employer.Answer: TRUEPage Ref.: I:4-15Objective: 2

30) The fair value of lodging cannot be excluded from gross income unless the employee is required to accept the lodging as a condition of employment.Answer: TRUEPage Ref.: I:4-15Objective: 2

31) A nursing home maintains a cafeteria that is used by employees, patients, and visitors. The value of free meals provided to employees while on duty so that they may be available for emergency calls is not taxable.Answer: TRUEExplanation: The meals are provided on the premises for the convenience of the employer.Page Ref.: I:4-15; Example I:4-23Objective: 2

32) All payments made by an employer to the family of a deceased employee are excluded from the recipient's gross income regardless of the reason for payment.Answer: FALSEExplanation: Only life insurance proceeds and gifts can be excluded. Funds paid directly by the employer are normally taxable as compensation unless based the facts and circumstances, the amount can be classified as a gift.Page Ref.: I:4-16Objective: 2


33) The amount of cash fringe benefits received under a cafeteria plan is taxable to an employee.Answer: TRUEPage Ref.: I:4-17Objective: 2

34) In the case of foreign-earned income, U.S. citizens may avoid double taxation of income by both the U.S. and the host country by utilizing a foreign tax credit or by electing the foreign earned income exclusion.Answer: TRUEPage Ref.: I:4-19Objective: 2

35) Kelly was sent by her employer to work on a special assignment in Paris for six months. Kelly will be able to exclude some of her income earned in Paris.Answer: FALSEExplanation: Because she is only working outside the U.S. for six months, she will not satisfy the 330-day requirement.Page Ref.: I:4-19Objective: 2

36) Which of the following is not excluded from income? (Assume that any amounts received by the taxpayer were kept.)A) public assistance payments.B) fair market value of prize won on a game show.C) gifts and inheritances.D) life insurance proceeds paid by reason of death.Answer: BExplanation: B) All except the prize are specifically excluded from income.Page Ref.: I:4-4Objective: 2


37) During the year, Cathy received the following:• Dividends of $4,000 from Lindsay Corporation. Cathy's father owned the stock and directed the corporation to send the dividends to Cathy.• A car worth $30,000 for being the 100th customer at a car dealership.• $5,500 cash gift from her uncle.• $10,000 inheritance from her grandmother.

What amount must Cathy include in gross income?A) $30,000B) $34,000C) $39,500D) $49,500Answer: AExplanation: A) Only the fair market value of the prize or award, $30,000, is taxable. Dividends are taxed to Cathy's father who is the shareholder. Gifts and inheritances are not taxable.Page Ref.: I:4-4; Example I:4-3 and I:4-4Objective: 2

38) Mae Li is beneficiary of a $70,000 insurance policy on her father's life. Upon his death, she elects to receive the proceeds in installments from the insurance company that carries the policy. She will receive $16,000 per year for five years. What are the tax consequences each year?A) All $16,000 each year is taxable.B) $10,000 interest is taxable in the first year.C) There is no taxable income.D) $2,000 of the $16,000 payment is taxable each year.Answer: DExplanation: D) The proceeds of $70,000 are not taxable. Therefore, $14,000 ($70,000/5 yrs) of the $16,000 is return of capital; the remaining $2,000 is taxable interest.Page Ref.: I:4-5; Example I:4-6Objective: 2

39) Rebecca is the beneficiary of a $500,000 insurance policy on her husband's life. She elects to receive $52,000 per year for 10 years rather than receive the entire amount in a lump sum. Of the amount received each yearA) $2,000 is taxable income.B) $50,000 is taxable income.C) $52,000 is taxable income.D) $5,000 per year is tax free as a death benefit.Answer: AExplanation: A) Each year, $50,000 of the payments are tax-free as return of capital (insurance proceeds). $500,000/10 = $50,000; thus, $52,000 - $50,000 = $2,000 is taxable.Page Ref.: I:4-5; Example I:4-6Objective: 2


40) Britney is beneficiary of a $150,000 insurance policy on her father's life. Upon his death, she may elect to receive the proceeds in five yearly installments of $32,000 or may take the $150,000 lump sum. She elects to take the lump sum payment. What are the tax consequences in year one?A) All $32,000 each year is taxable.B) $10,000 interest is taxable in the first year.C) There is no taxable income.D) The lump sum payment is taxable.Answer: CExplanation: C) Life insurance proceeds paid by reason of death are not taxable.Page Ref.: I:4-5; Example I:4-7Objective: 2

41) Cameron is the beneficiary of a $300,000 policy on the life of his mother. Cameron sells the policy to his brother, Parker, for $100,000. Parker subsequently pays premiums of $55,000. Upon his mother's death, how much of the insurance proceeds must Parker include in income?A) $0B) $55,000C) $145,000D) $300,000Answer: CExplanation: C) If there has been a transfer for valuable consideration, the life insurance proceeds are taxable but may be reduced by the investment in the policy. Thus, $145,000 {$300,000 - ($100,000 + 55,000)} is taxable.Page Ref.: I:4-5; Example I:4-8Objective: 2

42) Greg is the beneficiary of a $100,000 policy on the life of his mother. Greg gives the policy to his brother, Don. Don subsequently pays premiums of $40,000. Upon his mother's death, how much of the insurance proceeds must Don include in income?A) $0B) $40,000C) $60,000D) $100,000Answer: AExplanation: A) If a policy is transferred by gift, the resulting life insurance proceeds paid by reason of death are excludable from income.Page Ref.: I:4-5; Example I:4-8Objective: 2


43) Rianna paid $65,000 in premiums on a life insurance policy with a face value of $100,000. Upon reaching 65, Rianna surrendered the policy and collected $95,000. In the year of collection, Rianna will reportA) no income.B) $30,000 of taxable income.C) $5,000 of tax loss.D) $95,000 of taxable income.Answer: BExplanation: B) $95,000 - $65,000 = $35,000. The basis is recovered tax free.Page Ref.: I:4-6Objective: 2

44) David has been diagnosed with cancer and is expected to live less than 18 months. David is covered by a life insurance policy with a $400,000 face amount. David cashes in the policy early under a special option and receives 80% of the face amount or $320,000. In the year of collection, David will reportA) no income.B) $80,000.C) $320,000.D) $400,000.Answer: AExplanation: A) The amount David receives is excludable from gross income because he is a terminally ill individual.Page Ref.: I:4-6; Example I:4-9Objective: 2

45) Julia suffered a severe stroke and has been admitted to a private hospital where she is expected to remain for the rest of her life. She is certified by a licensed health care practitioner as being a "chronically ill individual." Her hospital expenses amount to $280 per day. She will receive $270 per day from a $500,000 life insurance policy as an accelerated death benefit. In 2012, she was in the hospital for 10 days and received $2,700. How much of this amount is taxable?A) $0B) $250C) $2,000D) $2,250Answer: AExplanation: A) Because she is a chronically ill individual, Julia may exclude the full amount she receives as it is less than the amount of actual expenses and the daily limitation of $310 established by law.Page Ref.: I:4-6; Example I:4-10Objective: 2


46) Bret carries a $200,000 insurance policy on his life and has paid premiums of $10,000 over the years. Dividends on the policy have totaled $8,500. Each year Bret has left the dividends with the insurance company. In the current year, the insurance company credited $800 of interest on the accumulated dividends to Bret's account. In addition, $600 of dividends was added by the insurance company. In the current year, Bret must report income ofA) $0.B) $600.C) $800.D) $1,400.Answer: CExplanation: C) Interest earned on accumulated dividends is taxed. The dividends are generally not taxed.Page Ref.: I:4-6Objective: 2

47) Benjamin and Jennifer are married and have AGI of $85,000 in 2012. They adopted a child while taking advantage of their employer's written adoption assistance program. They spent $15,000 in connection with the adoption, all of which was paid by the employer in accordance with the adoption plan. How much of the employer paid adoption costs must be included in their income?A) $0B) $2,350C) $12,650D) $15,000Answer: BExplanation: B) Under an adoption assistance program, an employer can provide a tax-free benefit of up to $12,650. Thus, $15,000 - $12,650 = $2,350 is taxable. The exclusion is phased-out beginning with AGI of $189,710.Page Ref.: I:4-6Objective: 2

48) Benjamin and Jennifer are married and have AGI of $150,000. In 2012 they adopted a child, while taking advantage of their employer's written adoption assistance program. The adoption cost $9,500, all of which was paid by the employer in accordance with the adoption plan. How much of the employer paid adoption costs may be excluded from their income?A) $0B) $3,150C) $9,500D) $12,650Answer: CExplanation: C) Under an adoption assistance program, an employer can provide a tax-free benefit of up to $12,650. The exclusion is phased-out beginning with AGI of $189,710.Page Ref.: I:4-6Objective: 2


49) Luke and Paige, a married couple, receive adoption assistance payments of $13,000 from their employer's qualified plan. They had spent $15,000 in connection with the adoption in 2012. The child does not have special needs. If their modified AGI is $195,710 how much may be excluded from income?A) $1,897.50B) $10,752.50C) $13,000.00D) $15,000.00Answer: BExplanation: B) The maximum exclusion is $12,650.The phase-out % is:

[($195,710 - $189,710) / ($229,710 - $189,710)] = 15%Reduction in exclusion is: $12,650 × 15% = $1,897.50

Exclusion is: $12,650 - $1,897.50 = $10,752.50.Page Ref.: I:4-6 and I:4-7; Example I:4-11Objective: 2

50) Hope receives an $18,500 scholarship from State University. The university specifies that $8,500 is for tuition, books, supplies, and equipment, while $10,000 is for room and board. In addition, Hope works part-time at the campus library and earns $5,000. Hope's gross income isA) $5,000.B) $15,000.C) $18,500.D) $23,500.Answer: BExplanation: B) $10,000 + $5,000 = $15,000. Room & board scholarships are taxable along with wages.Page Ref.: I:4-7 and I:4-8; Example I:4-13Objective: 2

51) Sarah receives a $15,000 scholarship from City University. The university specifies that $8,000 is for tuition, books, supplies, and equipment for classes. The other $7,000 is for room and board. Sarah works ten hours per week as a grader, for which she is paid $7,500 for the year. Of the total amount received, Sarah must include the following amount in gross incomeA) $7,000.B) $7,500.C) $14,500.D) $22,500.Answer: CExplanation: C) $7,000 + $7,500 = $14,500Page Ref.: I:4-7 and I:4-8; Example I:4-13Objective: 2


52) Which of the following statements regarding qualified tuition programs is incorrect?A) Distributions from income earned by a qualified tuition program are tax-free if used for qualified higher education expenses. B) Distributions of income are taxed to the donor if the proceeds are not used for higher education expenses.C) A qualified tuition program may be established by parents or grandparents.D) Contributions to a qualified tuition program are distributed tax-free.Answer: BExplanation: B) Distributions from income are taxed to the beneficiary if not used for higher education expenses.Page Ref.: I:4-8Objective: 2

53) Which of the following statements regarding the qualified tuition plans (QTP) is incorrect?A) Distributions can be made tax-free to pay for room and board at college.B) Distributions made from the QTP for college tuition will be tax-free in addition to qualifying for the American Opportunity credit or lifetime learning credit.C) Katie's parents had established a QTP for Katie, but she has received a "full-ride" scholarship. Katie's parents can name her sister as a replacement beneficiary of the QTP.D) Distributions of income not used for qualified higher education expenses are taxable and subject to a 10% penalty.Answer: BExplanation: B) The exclusion for the QTP distribution must be reduced by any amounts used to claim the American Opportunity credit or lifetime learning credit.Page Ref.: I:14-8Objective: 2

54) Amanda, who lost her modeling job, sued her employer for age discrimination. She was awarded $75,000 in lost wages, $25,000 for emotional distress, and $150,000 punitive damages. The amount taxable isA) $-0-.B) $150,000.C) $225,000.D) $250,000.Answer: DExplanation: D) $75,000 + $25,000 + $150,000 = $250,000Page Ref.: I:4-9; Example I:4-15Objective: 2


55) Elisa sued her former employer for discrimination. She was awarded $200,000 for lost wages, $30,000 for medical expenses related to emotional distress resulting from the discrimination, and $300,000 in punitive damages. The amount taxable isA) $0.B) $200,000.C) $500,000.D) $530,000.Answer: CExplanation: C) $200,000 + $300,000 = $500,000. The medical expenses are not taxable.Page Ref.: I:4-9Objective: 2

56) Derrick was in an automobile accident while he was going to work. The doctor advised him to stay home for eight months due to his physical injuries. The resulting lawsuit was settled and Derrick received the following amounts:

Compensatory damages for physical injury $80,000Punitive damages 95,000

How much of the settlement must Derrick include in ordinary income on his tax return?A) $-0-B) $80,000C) $95,000D) $175,000Answer: CExplanation: C) Compensatory damages for physical injuries are not taxable but the punitive damages are taxable.Page Ref.: I:4-9; Example I:4-16Objective: 2

57) Linda was injured in an automobile accident caused by another driver. Her son, Matthew, was in the automobile but not physically injured. The other driver's insurance company was required by a court to pay Linda $75,000 to cover medical bills relating to her injuries, $30,000 to compensate her for emotional distress attributable to the injuries and $40,000 of punitive damages. Matthew was paid $15,000 to compensate him for emotional distress attributable to his witnessing his mother's injuries. What is the amount taxable to Linda?A) $30,000B) $40,000C) $105,000D) $145,000Answer: BExplanation: B) Only the $40,000 of punitive damages are taxable to Linda as the other amounts are compensatory damages related to her physical injuries. Matthew's damage award of $15,000 is also excludable.Page Ref.: I:4-9; Example I:4-16Objective: 2


58) John is injured and receives $16,000 of income from a disability policy. John's employer paid 75% of the disability policy premiums and John paid the remainder. In addition, John's employer has paid all the $3,000 of premiums on a health policy that paid John's doctor bills of $10,000. How much of the benefits must John include in income?A) $3,000B) $10,000C) $12,000D) $16,000Answer: CExplanation: C) $16,000 × .75 = $12,000. The payments are taxable to the extent attributable to employer payment of premiums.Page Ref.: I:4-9; Example I:4-17 and I:4-18Objective: 2

59) Liza's employer purchased a disability income policy from an insurance company on behalf of all of its employees. The employer paid for two-thirds of the premiums, and the employees paid for the other one-third. Subsequently, Liza received $3,000 per month for 6 months she was unable to work. Liza will be taxed onA) $0.B) $6,000.C) $12,000.D) $18,000.Answer: CExplanation: C) $3,000 × 6 × 2/3 = $12,000. The payments are taxable to the extent the employer paid the premiums.Page Ref.: I:4-9; Example I:4-17 and I:4-18Objective: 2

60) Nelda suffered a serious stroke and was admitted to a nursing home for 140 days. Nursing home charges, including physician fees and other related expenses were $33,000. Under Nelda's long-term care insurance contract, she received reimbursements of $36,000. How much of the $36,000 reimbursement must be included in Nelda's gross income in 2012?A) $0B) $1,400C) $7,400D) $3,000Answer: AExplanation: A) $310/day × 140 days = $43,400 is the limit on the exclusion. Since her reimbursement was less than the maximum exclusion, the difference is not taxable.Page Ref.: I:4-9; Example I:4-19Objective: 2


61) Joe Black, a police officer, was injured in the line of duty. He received the following during the current year:

Salary $50,000Workers' compensation 5,000Compensatory damages for physical injury 18,000Punitive damages for physical injury 14,000Cash reward for preventing a break-in 2,000

What is the amount that is taxable?A) $57,000B) $66,000C) $71,000D) $84,000Answer: BExplanation: B) $50,000 + $14,000 + $2,000 = $66,000Page Ref.: I:4-9 and I:4-10Objective: 2

62) Richard is a key employee of Winn Corporation. The corporation provides Richard with $120,000 of group-term life insurance coverage. Only company executives receive life insurance coverage. The premium attributable to the coverage is $1,600. The uniform one-month group-term premium is one dollar per $1,000 of coverage. How much must Richard include in income due to the policy?A) $0B) $840C) $1,440D) $1,600Answer: DExplanation: D) If group term insurance coverage discriminates in favor of key employees, each key employee must include in gross income the greater of the premiums paid on his or her behalf or the amount determined by using the tables with no exclusion for the first $50,000 of coverage. Thus, the amount included is the greater of $1,600 or ($1 × 120 × 12 = $1,440).Page Ref.: I:4-12Objective: 2

63) Miranda is not a key employee of AB Corporation. AB provides Miranda with group term life insurance coverage of $140,000. The premiums attributable to the excess coverage are $1,300. The uniform one-month group-term premium is one dollar per $1,000 of coverage. How much must Miranda include in income?A) $0B) $1,080C) $1,300D) $1,680Answer: BExplanation: B) ($1 × 90,000/1,000 × 12 = $1,080)Page Ref.: I:4-12; Example I:4-21Objective: 2

64) All of the following items are excluded from gross income exceptA) working condition benefits.B) de minimis benefits.C) no additional cost benefits for employees.D) disability income from an employer-financed policy.


Answer: DExplanation: D) To the extent of employer-paid premiums, benefits paid under a disability policy are taxable.Page Ref.: I:4-9, I:4-13 and I:4-14; Topic Review I:4-2Objective: 2

65) Which one of the following fringe benefits allows for discrimination between highly compensated employees and other employees to be present?A) no-additional costB) qualified employee discountsC) recreation and athletic facilitiesD) working conditionAnswer: DExplanation: D) See Additional Comment in text. Working condition fringes are not subject to the discrimination rules.Page Ref.: I:4-13 and I:4-14; Topic Review I:4-2Objective: 2

66) A department store sold a stereo to an employee for $300, even though the retail price was $500. The gross profit percentage is 40%. Such discounts are available to all employees. How much income should be recognized by the employee from these transactions?A) $0B) $100C) $120D) $200Answer: AExplanation: A) The employee's purchase price is equal to the employer's cost ($500 - ($500 × 40%)) of $300 so the discount does not exceed the gross profit , and the full discount can be excluded. Page Ref.: I:4-13 and I:4-14; Topic Review I:4-2Objective: 2

67) Michael is an employee of StayHere Hotels, Inc. in Washington, DC. On his vacation, Michael travels to San Francisco and stays at a StayHere Hotel for six nights free of charge. The regular rate for a hotel room at StayHere in San Francisco is $300 a night. His ability to stay in the hotel without charge is based on the availability of empty rooms. How much income must Michael report due to the use of the San Francisco hotel room?A) $0B) $300C) $360D) $1,800Answer: AExplanation: A) The hotel rooms are considered a no-additional cost benefit.Page Ref.: I:4-13 and I:4-14; Topic Review I:4-2Objective: 2

68) Benefits covered by Section 132 which may be excluded from an employee's gross income do not includeA) employee's use of an employer-owned health club.B) membership fees in professional organizations.C) employer-provided vehicle for personal use.D) hotel employee's use of a vacant hotel room.Answer: CExplanation: C) Personal use of an employer-provided vehicle is taxable.Page Ref.: I:4-13 and I:4-14; Topic Review I:4-2


Objective: 2

69) All of the following fringe benefits paid for by the employer may be excluded from an employee's gross income exceptA) discounts on services of 25 percent.B) subscriptions to professional publications.C) recreational facilities on employer's premises.D) unused airline seats for airline employees where the employee is required to fly "standby."Answer: AExplanation: A) The maximum discount for services is 20%.Page Ref.: I:4-13 and I:4-14; Topic Review I:4-2Objective: 2

70) All of the following are requirements for excluding employee achievement awards except forA) tangible personal property other than cash.B) based on safety records or length of service.C) part of a meaningful presentation.D) if paid in cash, must be less than $400.Answer: DExplanation: D) The awards must not be cash.Page Ref.: I:4-14Objective: 2

71) Healthwise Ambulance requires its employees to be on 24-hour call and consequently gives them $800 per month housing allowance and a $200 per month food allowance. Ron, an employee of Healthwise, receives a salary of $40,000 per year (this does not include the allowances). Ron will be taxed each year onA) $40,000.B) $42,400.C) $49,600.D) $52,000.Answer: DExplanation: D) Cash payments are taxable. [($800 + $200) × 12] + $40,000 = $52,000Page Ref.: I:4-15Objective: 2


72) Which of the following item(s) must be included in the income of the respective employees?A) ABC Hospital Corporation provides free meals in the hospital cafeteria to employees while on duty in order that they be available for emergency calls.B) The state of California highway patrol organization provides its officers with a daily meal allowance to compensate them for meals eaten at any location while they are on duty.C) IBX Corporation requires its employees to work overtime three evenings each year when the company takes inventory. The corporation pays to provide catered dinners on its premises on these evenings.D) More than one, but not all, of the amounts must be included in income.Answer: BExplanation: B) The meals provided by ABC Hospital and IBX Corporation are not included in income because they are provided on the employer's premises and for the convenience of the employer. Because the officers regularly receive cash from the state of California instead of meals, the amount must be included in income.Page Ref.: I:4-15; Example I:4-23, I:4-24, and I:4-25Objective: 2

73) Lindsay Corporation made the following payments to the family of Luke Marshall, an employee who died during the year.

$5,000 for Luke's final paycheck that he failed to collect$10,000 for accrued vacation days as required by the employment contract$25,000 for in admiration of Luke's outstanding service to the community

What is the total amount that Luke's family must include in income?A) $0B) $5,000C) $15,000D) $40,000Answer: CExplanation: C) The employer was legally obligated to pay the $5,000 back wages and the $10,000 for the accrued vacation days. The payment for Luke's community service is a gift.Page Ref.: I:4-16Objective: 2

74) Fatima's employer provides a child care center where her two children stay while she works. She pays nothing for this service. If Fatima paid for comparable child care, it would cost $7,200 a year. How much of the child care benefits are taxable to Fatima?A) $0B) $2,200C) $5,000D) $7,200Answer: BExplanation: B) The maximum exclusion for child care assistance is $5,000. $7,200 - $5,000 = $2,200 of the benefit is taxable.Page Ref.: I:4-16Objective: 2


75) Ahmad's employer pays $10,000 in tuition this year for Ahmad to attend a graduate business program. How much of the employer-provided tuition is taxable to Ahmad?A) $0B) $4,750C) $5,250D) $10,000Answer: BExplanation: B) The exclusion for employer-provided tuition is limited to $5,250. $4,750 is taxable.Page Ref.: I:4-17Objective: 2

76) Carl filed his tax return, properly claiming the head of household filing status. Carl's employer paid or provided the following to Carl:

Wages $65,000Fair market value of qualified dependent care services 4,000Premiums for $50,000 qualified group term life insurance 500Medical insurance premiums 600

How much of this income should Carl report?A) $65,000B) $69,000C) $69,500D) $70,100Answer: AExplanation: A) Only the wages are taxable. Qualified dependent care services up to $5,000 are not taxable; premiums paid for group term insurance coverage up to $50,000 are not taxable; medical insurance premiums are not taxable.Page Ref.: I:4-10, I:4-11, and I:4-22Objective: 2

77) Rick chose the following fringe benefits under his employer's cafeteria plan. Which of his chosen benefits will be taxable?A) $150 cash per pay periodB) medical insurance on his familyC) dental insuranceD) group term life insurance of $20,000Answer: AExplanation: A) If an employee chooses cash as a benefit, the cash is taxable.Page Ref.: I:4-17Objective: 2


78) Tim earns a salary of $40,000. This year, Tim's employer establishes a cafeteria plan under which Tim signed a salary reduction of $2,500 for which $1,500 is to cover his health insurance premiums and $1,000 is available to reimburse medical expenses. During the year, he is reimbursed $900 for medical expenses. What is the total taxable to Tim this year?A) $37,500B) $37,600C) $38,400D) $40,000Answer: AExplanation: A) His taxable salary is $37,500 ($40,000 salary - $2,500 amount of salary reduction agreement). The payments for the health insurance premiums and the reimbursement of medical expenses are not taxable. Tim loses the $100 ($1,000 - $900) which was set aside for medical expenses and not claimed.Page Ref.: I:4-18; Example I:4-28Objective: 2

79) For 2012, the maximum foreign-earned income exclusion isA) $91,500.B) $92,900.C) $95,000.D) $95,100.Answer: DExplanation: D) The amount is established annually.Page Ref.: I:4-19Objective: 2

80) Jan has been assigned to the Rome office of ABC Corporation. She arrives in Rome on November 1, 2010 and does not return to the U.S. until March 5, 2013. During her stay in Rome, Jan earned $102,000 in 2012. Jan may excludeA) $0.B) $6,900.C) $95,100.D) $102,000.Answer: CExplanation: C) The exclusion is the lower of $95,100 or $102,000.Page Ref.: I:4-19Objective: 2


81) Jeremy, an American citizen, earned $200,000 during 2012 while employed in Switzerland. Jeremy is entitled to the maximum foreign-earned income exclusion. Jeremy also incurred $40,000 of deductible expenses attributable to the foreign-earned income. Jeremy may deduct how much in expenses?A) $0B) $19,020C) $20,980D) $40,000Answer: CExplanation: C) ($95,100/$200,000) × $40,000 = $19,020 is attributable to non-taxable income and may not be deducted. Therefore, Jeremy may deduct $40,000 - $19,020 = $20,980.Page Ref.: I:4-19 and I:4-20; Example I:4-30Objective: 2

82) Melanie, a U.S. citizen living in Paris, France, for the last three years earns a salary of $110,000 in 2012. Melanie's housing costs are $24,000 per year, which is reasonable. How much can Melanie exclude from income?A) $24,000B) $95,100C) $103,884D) $134,000Answer: CExplanation: C) $95,100 foreign earned income exclusion + $8,784 housing exclusion ($24,000 - $15,216)Page Ref.: I:4-20; Example I:4-31Objective: 2

83) In 2011 Betty loaned her son, Juan, $10,000 to help him buy a car. In 2012, before he repaid the $10,000, Betty told Juan that she was "tearing up" the $10,000 note as a graduation present. How should Juan treat the amount forgiven?A) taxable income in year of loanB) taxable income in year of forgivenessC) excludable gift in year of loanD) excludable gift in year of forgivenessAnswer: DExplanation: D) The amount forgiven is an excludable gift in the year of forgiveness.Page Ref.: I:4-20; Example I:4-32Objective: 2

84) For a taxpayer who is not insolvent nor under bankruptcy proceedings, the discharge of debt is generallyA) taxable.B) nontaxableC) partially taxable.D) none of the above.Answer: AExplanation: A) If the taxpayer is solvent at the time of cancellation of debt, any discharge of indebtedness is includable in gross income.Page Ref.: I:4-20 and I:4-21Objective: 2

85) Connor owes $4 million and has assets of only $1 million. He declares and files personal and business bankruptcy and his creditors approve a payment plan of $.25 per dollar. Connor has a net operating loss carryover of $2 million. The remaining 75 percent of his debt will be canceled. Connor must recognize income of


A) $0.B) $1 million.C) $2 million.D) $3 million.Answer: AExplanation: A) Gross income does not include income from discharge of indebtedness where discharge occurs in bankruptcy even if the reduction exceeds the available tax attributes.Page Ref.: I:4-20 and I:4-21Objective: 2

86) Exter Company is experiencing financial difficulties. It has assets worth $2 million, but owes liabilities of $2..1 million. It has a longstanding relationship with the bank. The bank has agreed to forgive $300,000 of debt principal. Because of this debt forgiveness, Exter will recognize income ofA) $0.B) $100,000.C) $200,000.D) $300,000.Answer: CExplanation: C) While debt forgiveness is normally recognized, Exter is insolvent to the extent of $100,000 ($2 million assets - $2.1 million liabilities). The remaining $200,000 of debt forgiven must be recognized.Page Ref.: I:4-21Objective: 2

87) The discharge of certain student loans is excluded from income if all of the following are present except forA) the loan must have been made by governmental, educational, or charitable organizations.B) the loan proceeds must have been used to pay the cost of attending an education institution or used to refinance outstanding student loans.C) the loan forgiveness must be contingent upon the individual's working for a specified period of time in certain professions.D) the loan forgiveness is based on age.Answer: DExplanation: D) Age is not a provision for excluding the forgiveness of a student loan.Page Ref.: I:4-21Objective: 2


88) This year, Jason sold some qualified small business stock that he acquired in 2006. His basis in the stock was $95,000 and he sold it for a $30,000 gain. How much of Jason's gain is taxable?A) $-0-B) $15,000C) $30,000D) $47,500Answer: BExplanation: B) $30,000 × .50 = $15,000. Note that qualified stock acquired between February 18, 2009 and December 31, 2011 may instead be eligible for a 75% or 100% exclusion.Page Ref.: I:4-22Objective: 2

89) In September of 2012, Michelle sold shares of qualified small business stock for $1,000,000 that had a basis of $200,000. She had held the stock for 7 months. Forty-five days after the sale she purchased other qualified small business stock for $1,100,000. How much of the gain will she recognize?A) $ -0-B) $100,000C) $800,000D) $900,000Answer: AExplanation: A) If the proceeds from the sale of small business stock held more than 6 months are reinvested in other small business stock within 60 days of the sale, no gain is recognized.Page Ref.: I:4-22Objective: 2

90) In September of 2012, Michelle sold shares of qualified small business stock for $1,000,000 that had a basis of $200,000. She had held the stock for 7 months. Forty-five days after the sale she purchased other qualified small business stock for $1,100,000. What is the basis in the new stock she purchased?A) $200,000B) $300,000C) $800,000D) $1,100,000Answer: BExplanation: B) Cost of new stock $1,100,000 Less unrecognized gain ( 800,000)Basis of new stock $ 300,000

Page Ref.: I:4-22; Example I:4-38Objective: 2


91) Bob, an employee of Modern Corp., receives a fringe benefit (in lieu of a salary increase) of $100. Bob is in a 33% tax bracket. The fringe benefit is nontaxable to Bob and is not deductible as an itemized deduction. Bob's after-tax savings from receiving the tax-free benefit isA) $0.B) $33.C) $67.D) $100.Answer: BExplanation: B) $100 × .33 = $33 tax savingsPage Ref.: I:4-23 and I:4-24; Example I:4-40Objective: 3

92) After he was denied a promotion, Daniel sued his employer claiming sex discrimination. He was awarded $20,000 to cover medical bills he incurred because of the related emotional distress, $80,000 to punish his employer for discrimination, and $50,000 to compensate him for lost wages. What is the amount that must be included in Daniel's gross income for the year?Answer: $80,000 + $50,000 = $130,000.Page Ref.: I:4-9; Example I:4-15Objective: 2


93) Randy and Sharon are married and have two dependent children. They also fully support Sharon's mother who lives with them and has no income. Their 2012 tax and other related information is as follows:

Total salaries - $160,000Bank account interest income - $3,500Municipal bond interest income - $1,500Value of employer provided medical insurance- $5,500Value of premiums for $50,000 of group term life insurance provided by employer - $500Dividend income—from ABC stock, $2,000Loan from Randy's parents - $5,000Gift from Randy's parents - $15,000Gain from the sale of qualified small business stock held more than 5 years - $15,000Total itemized deductions - $16,000

Compute Randy and Sharon's taxable income. (Show all calculations in good form.)Answer: Salaries $160,000 Bank interest 3,500 Dividend income 2,000 Gain from small business stock (50% of the gain is excluded) 7,500

AGI $173,000 Itemized deductions ( 16,000)Exemptions ($3,800 × 5) ( 19,000)Taxable income $138,000

The value of the employer-provided life insurance and health insurance, the gift from the parents and the municipal bond interest are excluded. Proceeds from a loan is not realized income.Page Ref.: I:4-10, I:4-11, and I:4-22Objective: 2


94) Mark, a cash basis taxpayer, died on September 30, 2012. His wife, Charlotte, provides you with the following information.

From January 1, 2012 until his death, Mark received a salary of $68,000. Charlotte received a salary of $35,000 during 2012. Mark had earned commissions of $20,000 which Charlotte received after his death. Charlotte was the beneficiary of a $100,000 whole life policy purchased by Mark and a $50,000 group term life insurance policy purchased by Mark's employer. The employer had paid premiums of $250 on Mark's behalf. In addition, the corporation paid Charlotte a $10,000 employee death benefit in Mark's name. All employees' families received similar benefits regardless of financial need. Mark and Charlotte had itemized deductions of $15,600. They have no children but provide 100% support for Mark's widowed mother who lives with them and has no income. What is the amount of their taxable income on their 2012 tax return?Answer: Mark's salary $ 68,000 Charlotte's salary 35,000 Mark's commissions 20,000 Death benefit 10,000 Gross income/Adjusted Gross Income $133,000 From AGI (> standard deduction or itemized deductions) ( 15,600)Exemptions ($3,800 × 3) ( 11,400)Taxable income $106,000

Life insurance proceeds paid by reason of death are not included in taxable income. The amount of employer-paid premiums of $250 is not included in taxable income since the employer provided $50,000 of group-term coverage.Page Ref.: I:4-5, I:4-10, I:4-11, and I:4-16Objective: 2


95) Jamal, age 52, is a manager for Triple W Company. His annual salary is $110,000 and he receives the following fringe benefits during the current year:

• Triple W pays for all employees' health and accident insurance. Triple W pays $4,000 for Jamal's health insurance during the year.• Triple W provides Jamal with group-term life insurance coverage of $200,000 during the year. The monthly inclusion amount per $1,000 of coverage is $.23.• Triple W has a flexible benefits plan in which employees may participate to pay any costs not reimbursed by their health insurance. Jamal has $1,600 withheld from his salary under the plan. During the year he receives reimbursements of $1,300.• Triple W pays parking costs for all management employees. Jamal's parking costs $220 month.• Triple W pays Jamal's annual membership dues of $450 to the Society of Human Resource Management Association. The company also subscribes to several management journals for Jamal costing $650 a year.• Jamal took a college class on employment law and Triple W reimbursed his tuition of $6,000 through its tuition assistance program for all employees.• Jamal's consumption of coffee provided by Triple W is valued at $700 a year.

How much income must Jamal report from his job?Answer: Salary $110,000 Excess life insurance coverage 414 [(200,000-50,000/1,000) × .23 × 12]Flexible benefits plan (1,600)Tuition assistance 750 ($6,000 - $5,250)Gross Income from employment$109,564

The health insurance premiums are excluded. Employer-provided parking of up to $240 a month is excludable. The membership dues and subscriptions are working condition fringe benefits and are not taxable. The maximum exclusion for tuition is $5,250. Coffee is a de minimis fringe benefit and is not taxable.Page Ref.: I:4-10 through I:4-14Objective: 2


96) Faye is a marketing manager for Healthy Corp. She earns a salary of $100,000 and has received the following benefits during 2012:• Healthy pays 75% of all employees' health and accident insurance coverage. Healthy paid $6,000 towards the cost of Faye's health insurance during the year.• Faye participates in the cafeteria plan and had elected to have $2,000 withheld from her pay to cover the remaining cost of the health insurance premiums and an additional $1,500 to cover dental and other health care costs not paid by insurance (i.e. funding a flexible spending account). The full $1,500 was used to pay for various qualifying medical cost.• Healthy pays the cost of disability insurance coverage for all employees. The insurance will pay 75% of salary if employees are out of work for a significant period. The cost of Faye's premiums was $600.• Healthy pays for the cost of veterinary insurance for all employees. The cost of coverage for Faye's dog was $400.• Healthy pays for the cost of daycare for its employees' children. The cost for Faye's two children was $8,000.• All employees receive a 20% discount on Healthy's products. The typical markup on their products is 25%. Faye enjoyed $1,200 of savings through the discount program.• Faye won the manager of the year award earlier in the year and received an all-expense paid week at a desert spa valued at $3,500.• Healthy pays Faye's annual membership dues of $500 to the American Marketing Association. • Healthy paid for the full $2,500 cost of Faye's attendance at the American Marketing Association's annual conference in Orlando.

How much income must Faye recognize from her employment?Answer: Salary $100,000 Faye's premiums paid (2,000)Flex Spending contribution (1,500)Veterinary insurance no exclusion available 400 Daycare $8,000 - 5,000 maximum 3,000

Vacation prizenot an eligible employee award 3,500

Total income recognized $103,400

The company-paid premiums for the health insurance and the disability insurance can be excluded. The value of the qualified employee discount can be excluded. The company payments of the professional dues and attendance at the marketing conference are excluded under the working condition fringe.Page Ref.: I:4-10 through I:4-18Objective: 2

97) In 2006, Gita contributed property with a basis of $500,000 and a fair market value of $3,000,000 to a qualified small business corporation for all of its common stock. She sells one-half of the stock after five years for $4,000,000. What is the amount of taxable gain on the transaction?Answer: The amount of the realized gain is $4,000,000 - $250,000 = $3,750,000. Fifty percent of the gain ($1,750,000) is eligible for the exclusion for qualified small business stock. $1,750,000 is taxable.Page Ref.: I:4-22; Example I:4-37Objective: 2


98) Adam purchased stock in 2006 for $100,000. He is considering selling it in 2012. It is currently worth $2,100,000 so he would realize a $2,000,000 gain. Adam is in the top tax bracket. Determine the taxes due under the following independent situations:

(a) Adam sells the stock, and no special circumstances apply. (b) The stock is qualified small business corporation stock.(c) The stock is qualified small business corporation stock. Within 60 days Adam invests $2,500,000 in new qualifying small business corporation stock.(d) The stock is qualified small business corporation stock. Within 60 days Adam invests $2,000,000 in new qualifying small business corporation stock.Answer: (a) $2,000,000 × 15% = $300,000 tax due.(b) $2,000,000 × 50% × 28% = $280,000 tax due.(c) All of the $2,100,000 proceeds are reinvested so none of the realized gain is recognized. No taxes are due.(d) $100,000 of the gain is recognized (only $2,000,000 of the $2,100,000 sales proceeds are reinvested). $100,000 × 50% × 28% = $14,000 tax due.Page Ref.: I:4-22; Example I:4-38Objective: 2

99) Discuss the requirements for meals provided by employers to be excluded from their employees' income. How is the de minimis rule distinguished from these requirements?Answer: Meals provided by an employer may be excluded from an employee's gross income if they are furnished on the employer's premises and for the convenience of the employer. In addition, Sec. 132 provides a de minimis exception. Some employers provide supper money to employees who must work overtime. If such benefits are occasionally provided to employees, the amount is excludable from the employee's gross income.Page Ref.: I:4-14Objective: 2

100) Discuss briefly the options available for avoiding double taxation for the U.S. citizen earning income from sources outside the United States.Answer: A U.S. citizen earning income from sources outside the United States may utilize the foreign tax credit whereby income taxes paid to foreign countries are subtracted from the taxpayer's U.S. income tax liability. Alternatively, the U.S. taxpayer who qualifies may claim the foreign-earned income exclusion whereby up to $95,100 in 2012 of earnings from personal services rendered in a foreign country is excluded from gross income. To qualify for the foreign-earned income exclusion, the taxpayer must meet the physical presence test or the bona fide residence test.Page Ref.: I:4-19Objective: 2


101) John, who is President and CEO of ZZZ Corporation which owns the ZZZ hotel chain, is working with his Human Resources department to design an employee fringe benefits package. He would like employees to receive discounts on goods and services provided by the corporation, would like to provide free hotel rooms to employees, would like to provide transit passes or pay for parking in metropolitan areas, and would like to provide recreational and athletic facilities. What issues should John consider in designing his package?Answer: All of the desired can be provided in a tax-advantaged manner so employees can enjoy these benefits without taxation if they are established and managed in accordance with requirements of the tax law. John should be aware that some employee fringe benefits (working condition fringes, for example) can discriminate in favor of highly compensated individuals without triggering taxable income. In addition, he should determine the requirements for nontaxability of no-additional-cost fringes (free hotel rooms), the maximum discounts allowed on goods and services to ensure nontaxability, as well as the rules for exclusions from income for nondiscriminatory parking and transit passes, etc. In addition, if exclusion status is achieved, the company will enjoy savings on payroll taxes.Page Ref.: I:4-13 and I:4-14; Topic Review I:4-2Objective: 2 and 3

102) Benedict serves in the U.S. Congress. In the current year, a lobbyist paid for Benedict to take a one-week vacation to Bermuda. Benedict did not incur any expense for the trip. What tax issues should Benedict consider?Answer: Does Benedict have income due to the receipt of the all-expense paid trip? Could the trip be considered a gift?Page Ref.: I:4-4Objective: 2

103) Chloe receives a student loan from a foundation which encourages students to pursue teaching careers. Under the terms of the loan, Chloe will not have to repay the loan if she teaches in a public school for ten years. What tax issues should Chloe consider?Answer: Does Chloe have income from the loan forgiveness? In what year(s) will the income be recognized?Page Ref.: I:4-20 and I:4-21Objective: 2

104) Taylor begins a new job as a logistics manager. His company advises him that he may need to travel internationally on occasion, so he should obtain a passport. The company reimburses Taylor for the cost of the passport. Taylor uses the passport when he vacations in Europe later in the year. What tax issues should Taylor consider?Answer: Does Taylor have income from his company's payment of his passport cost? Would this expenditure be considered a working condition or de minimis fringe benefit?Page Ref.: I:4-13; Topic Review I:4-2Objective: 2

105) Violet and Ashley are sisters. Ashley is unable to bear children, and she asks Violet to be a surrogate mother for her. According to the agreement, Ashley will pay Violet $25,000 and reimburse her medical expenses. What tax issues should Violet consider?Answer: Will the $25,000 cash and payment of medical expenses be income or a gift to Violet?Page Ref.: I:4-4Objective: 2


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Ind.chapter 4