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Ch. 4 Answers - Ea 5630" Ace 352 Gross Income Concepts...

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Unformatted text preview: Ea 5630"/ Ace 352 Gross Income: Concepts and Inclusions 4-5 DISCFSSION QUESTIONS 1. LI.) The Supreme Court considered this issue in Thor Power Tooi Co. v. Comm. (see page 4—5) and concluded that the conservatism principie “is hospitable to estimates, probabilities, and reasonable certainties; the tax law, with its mandate to preserve the revenue, can give no quarter to uncertainty.” p. 4—5 a. The overcharge to the customer created a liability equal to the amount of the overcharge. Therefore, the taxpayer did not experience an increase in wealth from an economic point of view. For tax purposes, the taxpayer would report gross income in 2007 and a deduction in 2008. b. From an economist’s point of view, the taxpayer suffered a $1,000 loss from the decline in value in the year of purchase, and then experienced a $3,500 ($6,500 — $3,000) gain in the year the stock was sold. For tax purposes, the taxpayer realized a $2,500 ($6,500 7 $4,000) gain in the year the stock was sold. The loss was not recognized in the year of purchase for tax purposes because the loss was not realized in that year. c. According to the economist, the carpenter should recognize income in the year the improvements were made, based on the increase in value of the property improved. Thus, the carpenter should recognize $26,000 ($140,000 — $100,000 — $14,000) when the improvements were made and no income in the year of sale. The economist may reason that the carpenter made $20,000 from the imputed value of his services and $6,000 from the sale of the property. Which of these options the economist selects depends on the fair market value of the property at the end of the tax year in which the improvements were made. For tax purposes, no income was realized until the property was sold, and the$26,000 was gain from the sale of the property. d. The discount the shareholder received on the purchase of the property of $5,000 ($15,000 — $10,000) is income (a constructive dividend) for tax purposes. From an economic perspective, the shareholder and his corporation may not be treated as separate entities, and thus the shareholder was receiving what he already owned and was retaining his $10,000 cash received by his corporation. So there is no income. pp. 4—3 to 4—5 Charley received something of value from the casino. Under the broad concept of income, the airfare and hotel accommodations would be considered income. However, Charley could argue that the income should be matched with his $15,000 in gambling losses on the trip, and when the income and losses are combined, the net effect is an economic loss. As will be discussed later in the text, the net loss is not deductible, but at least the gambling losses can be used to offset the income from his gambling activities. pp. 4—3 to 445 Reno was favored, because he was not taxed on the value of his work on the automobile. He spent $3,400 of his money on. the automobile, which presumably was from earning $4,533 {$3,400 + (1 w 25)] and paying tax of $1,133. The value added by his work of $3,600 ($7,000 4 $2,000 — $1,400) on the automobile was not subject to income tax. Therefore, Reno paid only $1,133 to have the earnings needed to acquire an automobile whose value was a $7,000 automobile. For Tom to acquire a simiiar car, he was required to earn taxable income of $9,333 [$7,000 + (l — 25)] and pay income tax of $2,333 ($9,333 — $7,000). pp. 4«3 and 4—4 4—6 2009 Individual Volume/Solutions Manual 5. Because Cecil does not know how much he will receive from the sale of automobile parts, and it is impractical to determine the cost of individual automobile parts, he could reason that all sales proceeds are a recovery of capital until he has received his cost of $250, and all subsequent proceeds are included in gross income. The IRS may argue that Cecil should allocate his cost of the car among the various parts, which may be impractical. p. 4—6 6. The check is a cash equivalent. The employer, as principal, must recognize the income when his agent, the employee, collected it in 2008. pp. 4—7 to 4-10 and 4—16 7. a. The income should be reported in 2009. In 2008, Jared has not received anything of value. b. The significance of when the income is recognized by Jared relates to (l) the time value of money—if the tax is deferred, the present value of the tax decreases; and (2) the marginal tax rates‘the taxpayer may be subject to different rates between years because of changes in the tax law, changes in his or her taxable income, changes in the taxpayer’s filing status, and changes in the entity status. pp. 4—7 to 4—9 8. a. The issue is when does Albert recognize gross income from the dinosaur bones: when he discovers the bones, or when he sells the property. The situation is analogous to an owner discovering oil on his or her property. In 2008, Albert did not receive anything he did not already own. Therefore, no income is realized until the bones are sold in 2009. This treatment is consistent with the wherewithal to pay doctrine. b. Albert probably will not be allowed to allocate any basis in the land to the bones. Therefore, his gross income from the sale of the bones in 2009 is $26,000. pp. 4-2 to 4—5 9. a. Allyson must report income under the original issue discount (OID) rules in each of the four years, 2008, 2009, 2010, and 2011. 13. Clearly, the original issue discount rules were not enacted to relieve the taxpayer’s compliance burden as no such burden existed. In fact, the OID rules add significant complexity to a relatively simple fact pattern. Without the OlD rules, the income would all be reported in one year (i.e., when the investment matures), and the problems of allocating the income among the four years would be obviated. Apparently then, equitable considerations probably were the motivation for the OlD rules. Without the (ND rules, cash basis taxpayers could easily defer their tax obligations by selecting investments issued at a discount. Accelerated and timely revenue recognition also likely was a contributory factor. pp. 4—10 to 4-l2 10. The income from the Series EE bond is deferred until maturity, in three years, but the interest on the bank account is taxed each year under the OlD rules. The Series EE savings bonds are exempt from the OID rules, and no interest is included in gross income until the BE bonds’ maturity date in three years. Therefore, with the Series EE bonds, the taxpayer is earning interest on his deferred taxes. pp. 4-11 and 4-12 11. 12. 13. 14. 15. 16. 17'. 18. Gross Income: Concepts and Inclusions 4-7 The revenue must be recognized by Parchment, an accrual basis taxpayer, when all the events have occurred to fix the company’s right to receive the income. Under the original terms, the income is recognized when the customer receives the goods. Any returns reduce taxable income in the year the customer returns the goods. Under the proposed terms, no income would be recognized until the customer agrees to retain the goods. p. 4—13 1f Rex sells the car, he must pay the tax on the gain of $3,800 ($9,000 — $5,200). If Rex gives the automobile to his daughter and she sells it, she will be taxed on the gain of $3,800. Thus, the increase in value that is economically attributable to Rex will become his daughter’s income. If Rex is in a higher marginal tax bracket (probably the case), the family unit will generate tax savings by Rex’s daughter selling the car. Thus, gifts of appreciated property can be a useful tax planning concept. pp. 4-15 to 4-17 Sarah is not correct in her analysis. Sarah and the attorney are not partners. Therefore, her gross income is the full amount of the settlement of $300,000. Sarah is entitled to a deduction for $100,000. Since the settlement is associated with a discrimination suit, the deduction is a deduction for AGI. See the Tax in the News on p. 4—18. Tom must include in his gross income his share of the partnership’s income, regardless of Whether the profits are actually distributed. Therefore, Torn must recognize as gross income from the partnership $150,000 ($300,000 X 50%) in 2008 and $400,000 ($800,000 >< 50%) in 2009. pp. 4—17 and 4~18 A joint return cannot be filed by Mike and Debbie, unless Debbie can be located and she consents to filing a joint return. Mike cannot qualify as an abandoned spouse because he has no dependent children. On separate income tax returns for 2008, Mike and Debbie each must include one—half of the community’s income. This results because they lived together for part of the year. Thus, Mike must include in his gross income his share of Debbie’s earnings for the year, including a share of Debbie’spost-separation earnings. pp. 4-18 to 4- 20 The purpose of the alimony recapture rules is to prevent disguising a nondeductible property settlement as alimony. pp. 4—20 to 4-22 Considering only taxes, Jean should accept the securities. The high basis in the stock will provide Jean with a tax benefit. She will have a carryover basis of $115,000 in the securities. If she sells the securities for $100,000, she will recognize a $15,000 loss. She will be allowed to offset this loss against other capital gains. If she has no capital gains, she can offset $3,000 of the loss against ordinary income each year, as discussed in Chapter 3. Thus, the loss would offset other income on ' Jean’s income tax return. pp. 4»20 and 4421 The following issues are suggested from the facts presented: 0 Will gains and losses from the sale of property pursuant to the divorce be subject to tax? 0 Are the child care payments deductible? in Would payments with respect to William’s contribution toward her education be taxable to her? a What is their filing status until the divorce has been completed? 4-8 19. 20. 21. 22. 2009 Individual Volume/Solutions Manual 0 Should the payments be arranged so that they are deductible by William and taxable to Abigail? if the payments are taxable to her, what additional amounts should she request in exchange for agreeing to terms that are tax favorable to William? o is the daycare that is being provided by the grandparents taxable to either William or Abigail? - Who will be able to claim April as a dependent? pp. 4-20 to 4—23 David and Mary should consider the tax implications of the agreement. The property can be transferred without recognition of gain by David or Mary. However, Mary’s cost basis in the stock will be the same as David’s. If his basis is less than the fair market value ofthe stock, Mary will recognize gain when the stock is sold assuming the stock maintains its value after being transferred to Mary. The cash payments may be alimonyiincome to Mary and deductible by David. The requirements for alimony are that the cash payments must cease with the death of the payee, the agreement must not specify that the payments are not alimony, and David and Mary cannot live in the same household when the payments are made. The reference to the daughter raises issues as to whether some or all of the cash payments are nondeductible child support. if the payments are reduced upon the happening of a contingency related to the child, the amount of the reduction is deemed child support. pp. 4—20 to 4—23 Usually the lender is in a higher marginal tax bracket than the borrower. So tax savings would result from this tax rate differential. In addition, the borrower may not be permitted to deduct the interest, (e.g., the funds were used for consumer purchases). Thus, in this situation, the borrower’s interest income will not be offset by the lender’s interest expense. pp. 4—23 to 4-25 The interest imputed at the Federal rate is both interest expense and additional compensation to the CEO. This amount is $30,000 ($1,000,000 X 6% X 1/2). The borrower may be allowed to deduct the imputed interest on the home mortgage (see Chapter 10). Rose Corporation has interest income of $30,000 and compensation expense of $30,000. pp. 4—23 to 435 and Concept Summary 4—2 The following issues are suggested from the facts presented: o Is the corporation required to impute interest income on the loan to Brad? 0 is Brad required to recognize income from the loan proceeds? a Is Brad required to recognize income in respect to the favorable interest rate? o Is the loan made to Brad in his capacity as a shareholder or as an employee? I! Is the loan subject to the original issue discount rules? pp. 4—11 and 4—23 to 4—27 The entire $8,000 must be included in her gross income because she has lived longer than her life expectancy (18.4 years according to Table 4—1). She has recovered all of her cost of the annuity over the previous 19 years. pp. 4—27 to 4—30 24. 25. Gross Income: Concepts and Inclusions 4-9 Under the broad concept of gross income contained in the Code, premiums on group term life insurance purchased by employers for employees would be included in the employee’s gross income. Therefore, § 7'9 creates an exclusion of premiums on up to $50,000 of insurance coverage for employees. pp. 4—31 and 4—32 The $8,000 recognized gain ($13,000 — $5,000) will be taxed at 5% as a long~term capital gain. However, the gain will cause some of her Social Security benefits to be subject to tax. Without the additional gain, none of Evelyn’s Social Security benefits will be subject to tax. However, the additional $8,000 recognized gain included in gross income and adjusted gross income will cause $3,000 of Evelyn’s Social Security benefits to be included in her gross inCOme. .5[$16,000 + $8,000 + .5($14,000) — $25,000] = $3,000. Therefore, the additional tax that would result from the gain would be as follows: Tax on additional gross income from Social Security ($3,000 X 15%) $450 Tax on long-term capital gain ($8,000 X 5%) 400 Additional tax liability 5&0. pp. 4-33 and 4-34 PROBLEMS 26. a. The $1,000,000 is an increase in wealth realized during the year and thus is income under the tax accounting rules. However, under economic theory she may have recognized some of the income when she entered into the long—term contract. b. The $800 amount received for baby sitting is income for both economic and tax concepts of income. c. The taxpayer has $2,000 of income in 2008 under economic and tax concepts of income. He sold the securities in 2008 for $2,000 more than their cost and value in 2007. The sale proceeds less the cost of the securities were his gross income, regardless of whether the securities were financed with his previously accumulated cash or through borrowing. d. The $200,000 increase in value during the year would be economic income for the year, but it would not be gross income for tax purposes because the gain was not “realized” during the year. e. The taxpayer realized gross income of $1,500 from the use of the car under both economic and tax concepts of income. f. The taxpayer has $1,200 ($2,000 7 $800) of income under the economic concept of income. However, he had no gross income for tax purposes because he did not realize a gain from transactions with others. pp. 4—3 to 4—5 4-10 27. 28. 29. 2009 Individual Volume/Solutions Manual Amos should use the cash method of accounting so that the income from services billed to the insurance company can be deferred until the income is collected. Under the cash method, the amounts billed to the insurance companies will be continuously deferred until the year following his final year of practice. That is, with the cash method of accounting as compared to the accrual method, Amos will enjoy a deferral of two months of billings to insurance companies. Amos’s marginal tax rate may be lower in the first year of practice than in subsequent years. Thus, accelerating income through the use of the accrual method would have some benefit. But the benefit of the lower rates probably would not equal the benefit of deferral. pp. 4—7 to 4-9 _ The taxable bond and reinvested earnings will accumulate at an after-tax rate of 4.32% [(1 - 28) X .06] to equal $12,355 at the end of 5 years [$10,000 >< (1.0432)J = $10,000 X 1.2355 = $12,355]. The income from the Series EE bond will not be taxed until maturity in five years, and the after-tax value will be $12,210 [$13,070 — .28($l3,070 — $10,000)]. Thus, the after—tax proceeds from the land must exceed $12,355. Because the gain on the land will be taxed as long-term capital gain, the sales proceeds less 15% of the appreciation must exceed $12,355. $10,000 + (l — .15)(X* $10,000) 2 $12,356 $10,000 + .85X.’ $8,500 = $12,356 .85X = $10,856 x = $12,772. Thus, the land must increase in value by at least $2,772 to yield a greater after—tax return than the investment in either of the bonds. It should be noted if the land increases in value to $12,772, it will have a smaller before- tax value than the Series EE bond, but the land will have a greater after—tax value. The greater after-tax value of the land results from the lower tax rate. Also, the taxable corporate bond has a greater before~tax rate of return than with the Series EE bond, 6%, but a lesser after—tax return because income from the bond is taxed each year. Thus, the tax rate and the timing of the tax payments are determinants of the after—tax rate of return from an investment. pp. 4—3 to 4—5, 4—35, and 4—36 a. Olga has $300 of interest income and a recognized gain of $500 ($10,800 — $300 ~ $10,000). b. Olga does not recognize income from using the stock as collateral for the debt. Her assets (cash) and liabilities increased by the same amount, and she continued to own the stock. Thus, there is no realized gain. (2. Mere increases in the value of an asset are not included in gross income. Note the attorney’s fee should be added to Olga’s cost of the property in calculating her basrs for the vacant lot. pp. 4—3 to 4—6 Gross Income: Concepts and Inclusions 4—11 30. a. The $1,500 is a dividend from the corporation to Amos. The corporation was entitled to the rebate. The rebate was a reduction in the cost of the corporation’s automobile. The assignment of the $1,500 to Amos was an economic benefit realized solely because he was the controlling shareholder and thus is a dividend to him. b. The $5 0,000 payment received under the covenant is included in Amos’s gross income because the payment is an increase in wealth realized. c. The neighbor’s actions that increased the value of Amos’s property by $1,500 do not result in the realization of income by him. Amos’s wealth has increased, but the realization requirement is not satisfied, since he did not receive any additional property nor were any improvements made to his property. Amos will not realize this increase in wealth for tax purposes until he sells the property. pp. 4-7 and 4-8 31. a. Gross income using cash method: Cash collections from customers $150,000 Under the cash method, income is recognized when cash or its equivalent is actually or constructively received, regardless of when it was actually earned. Neither gross income nor taxable income is affected by the uncollectible accounts. Income was not recognized when the income was earned. The deposit is not Al’s money. Rather, Al is the agent holding the money on behalf of the client. b. Gross income using accrual method: Cash collections $ 150,000 Less: Beginning accounts receivable (25,000) Plus: Ending accounts receivable 60,000 $185,000 c. A] should use the cash method so that he will not have to pay income taxes on uncollected accounts receivable. pp. 4—7 to 4—9 32. a. Accrual basis gross receipts Cash received $1,500,000 Less: beginning accounts receivable (200,000) Less: bank loan (100,000) Add: ending accounts receivable 400,000 Gross receipts £1,600,000 b. Gross income Gross receipts $1,600,000 Cost of goods sold: Purchases $1,200,000 Beginning inventory 100,000 Ending inventory t 300,000 ) Cost of goods sold ($1,000,000) Gross income i 600,000 pp. 4-7 to 4—9 4-12 34. 2009 Individual Volume/Solutions Manual Hoffman, Smith, and Willis, CPAs 5191 Natorp Boulevard Mason, OH 45040 October 1, 2008 Ms. Amanda Sims Managing ...
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