Ch. 5 Answers

Ch. 5 Answers - Question} Problem 4'}..me OOH-JGNUI ll 12...

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Unformatted text preview: Question} Problem 4'}..me OOH-JGNUI ll 12 13 14 15 16 I? 18 19 20 21 22 23 24 25 26 2? *28 29 30 . 65‘! Hsédour CHAPTER 5 GROSS INCOME: EXCLUSIONS SOLUTIONS TO PROBLEM MATERIALS Status: Q/P Present in Prior Topic Edition Edition Inheritance and compensation Unchanged 1 Income from bequests New Gift to employees Unchanged 3 Life insurance proceeds and “income in respect of a New decedent” Gift versus compensation Unchanged 5 Life insurance: accelerated death benefits Unchanged 6 Life insurance: transfer for valuable consideration Unchanged 7’ Life insurance: cash surrender value and Unchanged 8 accelerated death benefits Scholarship and lodging New Damages Unchanged 1 0 Damages Unchanged l 2 Unemployment compensation and workers Unchanged l3 compensation Health Savings Account (HSA) Unchanged 14 Salary decrease versus health insurance premiums New Cafeteria plans versus flexible spending plans Unchanged 16 Fringe benefits: employee discounts Unchanged 1? Alternative compensation options Unchanged 18 Qualified transportation fringe Unchanged 19 Employer provided facilities Unchanged 20 Qualified retirement planning services New Foreign earned income Unchanged 21 Taxable versus tax-exempt bonds Unchanged 22 Tax benefit rule New Qualified state tuition program Unchanged 24 Tax benefit rule versus subsequent income Unchanged 25 payments .lncome from discharge of indebtedness New Income from discharge of indebtedness Unchanged 2? Life insurance, inheritance, and gifts New Life insurance and accident benefits Unchanged 29 Accelerated death benefits New 5-] Que st i on! Problem 31 32 33 34 35 36 3'? 38 39 40 41 42 43 *44 45 *46 4? 4s *49 50 51 *52 S3 54 55 56 S7 58 *59 *60 Research Problem Chm-buns.)— 2009 Individual Volume/Solutions Manual Tees Gifts and fringe benefits and disaster area payments Death benefits Life insurance: use of proceeds Scholarship Scholarship Damages Damages Health insurance, medical reimbursement Fringe benefits Medical reimbursement plan versus flexible benefits plan Long-term care insurance benefits Meals and lodging Meals and lodging Accident and health plans, athletic facilities Working condition fringe Fringe benefits versus taxable compensation Flexible benefils plan Fringe benefits Foreign earned income Tax benefit rule, tax-exempt income Unrealized gains and losses, stock dividends, and dividend reinvestment Taxnexempt bonds versus taxable bonds Tax—favored educational savings programs Educational savings bond exclusion Qualified state tuition program Tax benefit rule Income from discharge of indebtedness Income from discharge of indebtedness Cunmlative Cumulative Damages Discharge of indebtedness Fringe benefits Gross income lntemet activity Internet activity Status: Present Edw_ New Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Modified Unchanged New Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged New Unchanged Modified Unchanged Unchanged Unchanged Unchanged Modified Modified New Unchanged Unchanged Unchanged Unchanged Unchanged *The solution to this problem is available on a transparency master. on) 53 S4 55 56 5? 58 59 60 @U‘ILWN 29.21. 29b. 29c. 29.d. 29.e. 30.21. 30.13. 31. 32. 33.3. 33.13. 33.c. 34.a. 34b. 35. 36a. 36.13. 37a. 37b. 37.0. 37.d. 37.e. 38. 41. 43.a. 43.b. Gross Income: Exclusions 5-3 CHECK FIGURES $2,500 and $4,000. 43.c. $1,500. 44. $0. $0. 46.a. $75,000 —- $45,000 — premiums paid. 46b. $15,000 capital gain on stock sale; 46.c. $0 gross income if “terminally i11" 47.a. on insurance policy. 47.13. 815,000 capital gain on stock sale; 47d. $20,000 ordinary income on life 48.21. insurance policy. 48b. The tips of $8,000 and free housing of $9,000 are gross income. 48.c. Include $8,000 in gross income. 48.d. Fay has $0 gross income on the 48.e. receipt ofthe $1.75 million life 48.1‘. insurance proceeds. $20,000 ofinterest is included in 49.a. gross income. 49.b. $0 gain. 50. Room and board of $7,500 are 51.a. includibie. 51.b. Additional compensation to Willy’s 52. father. $2,100 is includible in 2009. 54.21. Leigh must include $50,000 in 54b. gross income. 54.0. Yes. include $40,000 in gross 55. income. 56a. $150,000. 56b. $50,000. 56c. $50,000. 57.3.. $30,000. 57h. $3 00,000. 58a. $4,500. 58b. Include $800 in gross income. 58c. Include $5 per meal in gross income. 59. Included $200 in gross income. 60. Lodging included in gross income. Decrease in disposable income $9,932. $9,050; $10,393; 31 1,015. $6,332; $7,272: $7,264. $4,550; $4,550; $4,550. $500. $1,500. Low end. include $0. Exclusion allowed for $2,640; include $120. Exclusion allowed. Exclusion allowed. Exclusion allowed. No exclusion for Polly; plan is discriminatory. $178,640. $187,400. $2,650. $700. $0 gross income. Greater after-tax yield on corporate bond. Exclude $3,072. Include $5,000 for Susie. Include $5,000. Qualified tuition program. $1,000. $4,000. $5,000. Additional tax $7,000. Fran can defer the tax. $0 gross income. $6,000. $4,000. Refund due for 2007 $371. Refund due for 2008 $102. 5-4 2009 Individual VolumefSolutions Manual DISCUSSION QUESTIONS 10. Tom received the farm as compensation for services in accordance with the contract with Uncle John. Therefore, when Tom receives the farm, the value of the farm must be included in his gross income. pp. 5-4 and 5-5 Albert is the beneficiary of Hattie’s life insurance policy and therefore can exclude the life insurance proceeds of $50,000 from gross income. However, Albert must include the $2,000 interest in gross income. pp. 5—4 to 55? Because the majority of the beneficiaries of the nonprofit foundation created by Pearl are employed by the company, the IRS may argue that the foundation was created for the benefit of Pearl employees and, therefore, the benefits received by the employees cannot be excluded from the employees’ gross income. l-lowever the patients may quality for exclusion if Pearl is located in a “qualified disaster area.” pp.5-4 and 5-5 Wade must include in his gross income $50,000 as “income received in respect of a decedent.” The employer is not required to include in its gross income the $200,000 it received as the beneficiary of Hanna’s life insurance policy. Wade can exclude from his gross income the $200,000 he received as an inheritance. pp. 5-5 to 5-7 Matt is incorrect. The intended tip, $1, is not a gift, but rather is compensation for services. The additional amount received, $99, was not received out of the generosity of the customer, but rather out of a mistake. Matt is $99 richer as a result of the mistake, and should include this amount in his gross income (rather than treating it as a gift). p. 5-5 Ted would have a realized gain of $18,000 ($50,000 — $32,000). However, the realized gain from the insurance policy is not included in Ted’s gross income because of the exclusion for accelerated death benefits available to taxpayers with a terminal illness who transfer their life insurance policy for consideration. p. 5-? SinCe Amber had taxable income in 2007, it received a tax benefit from writing off the receivable. So Amber would include $5,000 in gross income in 2008 under the tax benefit rule. The insurance proceeds would not be excluded from gross income because the insurance contract proCeeds were in consideration of the loan and not payable merely as the result of Aly’s death. p. 5-8 Ed must include his realized gain of $6,000 ($45,000 cash surrender value — $39,000 adjusted basis) in his gr05s income. However, Sarah can exclude from her gross income her realized gain of $6,000 ($45,000 cash surrender Value — $39,000 adjusted basis) because she has a terminal illness (i.c., the accelerated death benefits exclusion). What the funds are used for is not relevant in determining the effect on the taxpayer‘s gross income. pp. 5-6 to 5—8 Joe’s gross income is $1,500. The use ofa room valued at $3,000 is excluded from gross income as mandatory lodging provided on the employer’s business premises for the convenience of the employer. The scholarship also can be excluded from Joe’s gross income. pp. 5-15 to 5-1? Assuming the $160,000 is a defensible amount, Sarah should accept the counter-offer made by the company and its insurance company. Under Sarah’s offer (part compensatory and part punitive), she would receive $230,000 (with the $80,000 punitive damages included in her gross income) and would have a tax liability of $26,400 ($80,000 X 33%) on the punitive damages. Thus, her after-tax cash flow would be $203,600 ( $230,000 — $26,400). ll. 13. 15. 16. Gross Income: Exclusions 5-5 Under the company’s _ proposal, Sarah would receive $210,000 (with none of the compensatory damages included in her gross income because they result from her physical personal inju1y) but would not have any tax liability. So her after-tax cash flow from the counter-offer would be $210,000. pp. 5-1 1 and 5-12 No. The $15 million amount that Wes received is excluded from his gross income as compensatory phys1cal personal injury damages even though the amount received is based on the projected lost income. The $10 million of punitive damages that Wes receives must be included in his gross income. Sam‘s salary of $25 million must be included in his gross income. pp. 5-1 1 and 5-12 Holly can exclude the $12,000 of workers” compensation benefits from her gross income, but Jill must include the $12,000 of unemployment compensation she received in her gross income. p. 5-13 and Chapter 4 Health Savings Accounts (HSAs) are an alternative to traditional health insurance. The employer provides a medical insurance plan with a high deductible. The high deductible reduces the cost of the insurance premiums to the employer. The employee is expected to pay part (or all) of the. deductible by withdrawing from the employee savings account created with the employee‘s tax deductible contributions or with the employer‘s contributions to the account. Any employer contributions to the savings account are excluded from the employee’s gross income. Withdrawals used to pay medical expenses not covered by the medical insurance plan are excluded from the employee’s gross income. The employee can make taxable withdrawals for other pu1poses. The earnings on the HSA investments are exempt from tax. Dcductiblcs under traditional health insurance plans are lower. The savings feature ofan HSA is not present in a traditional plan. pp. 5-13 to 5~15 Paul would find the first option the least objectionable. Under option (1) he would be required to pay $6,000 per year. Assuming he cannot deduct the insurance as a medical expense because ofthe 71.5% floor. his cash flow after—tax and health insurance premiums will decrease by $6,000. Under option (2) his cash flow after-tax and health insurance premiums would decrease by 36,3?5 [(1 — .15) is $1500]. Betty would Fare better under the second option. As in Paul's case, with option (1) she is $6,000 poorer than without any change. But under option (2) she would be oniy $4,875 [(1 — .35) >< $3,500] worst off. pp. 5-13 to 5-15 With a cafeteria plan, the employee receives a salary and is also provided by the employer with a tixed amount that he or she can allocate among a range of possible nontaxable fringe benefits and taxable benefits. With a flexible spending plan. a portion of the employee‘s salary is set aside for specific uses that would have been excludible from gross income had the employer paid these expenses. The employee‘s gross income is reduced by the amount that goes into the flexible spending account and the withdrawals are excluded from gross income. However, any unused funds are forfeited by the employee. pp. 5-19 and 5-20 The discount on the price of the automobile of $3,120 is a qualified employee discount. The discount can be excluded From Ted‘s gross income. However, Ted must include in gross income 80% of the transfer service fee ot" $175, which is $140 (SITS >< 80%). The maximum qualified employee discount that can be excluded for a service is 20%. pp. 5-20 and 5-21 l8. [9. 20. 22. 2009 Individual Volumei’Solutions Manual The second potential employer must of fer Zack at least $58,000. Zack needs $8,000 in before- tax dollars to purchase health insuranee costing $6.000 [(36,000 premiumle — .25) =' 38.000]. Therefore, the seeoud offer must have a salary of $58,000 (850,000 + $8,000). p.5-l3 a. Tom must include the $100 in gross income. Ted is allowed to exclude the $100 as a qualified transportation fringe. b. Tom paid $100 for transportation cost and was reimbursed for that amount. Therefore, Tom’s before-tax cost was $0. However. Tom is required to include the $100 in gross income and thus must pay an additional $28 (X .28) tax on the reimbursement, which is his after-tax cost of commuting. Ted‘s after-tax cost of commuting is $0 because he is reimbursed for the out-of—pocket cost and is not required to include the reimbursement in income. p. 5—23 The issues all relate to whether the employees would realize gross income from the employer providing the facilities. {f the employee does have gross income, the next question is: does the benefit qualify under one ofthe exclusions provided in the Code? 0 Does the employee experience an economic benefit from using the facility? 0 Does the walking trail qualify as an excludible “athletic facility"? I ls the benefit de minimis? o Is the benefit a no—additional-cost service? pp. 5-20 to 5-23 Only the retirement planning benefits can be excluded from gross income. 13. 5—24 A possible advantage to taking the three-month job in the foreign country is that Marla may then satisfy the requirements for the foreign earned income exclusion for all of her earned income for the twelve-month period (i.e., indexed statutory ceiling of $87,600 in 2008). This would be a substantial benefit. pp. 5-25. to 5~2? The Virginia bonds yield the greater after—tax yield (4.5%). The corporate bonds after~ Federal and after~Virginia tax yield is 4.2% (l —- .35 — .05) (7%). The Maryland bond's after-Virginia tax yield is 4.3?% (l — .05) (4.6%). However, assuming, that Tedra itemizes her deductions on her Federal income tax return, the Virginia income tax on the Maryland bond is deductible and thus will reduce her Federal income tax by 08% [.35(.05){4.5%)]. The after-Virginia and after-Federal tax yield on the Maryland bond is therefore 4.45% {4.37% + 08%). pp. 5-28 and 5—29 Sam would be required to include the $500 in gross income if he obtained a tax deduction for the taxes paid in 200? and the deduction reduced his taxable income in 200? by at least ssoo.p.s—32 24. 25. 26. Gross Income: Exclusions 5-? Neither child must include anything in his or her gross income. The $15,000 ($40,000 — $25,000) gain with reSpect to Pegg ', the child who attended college, is exempt because the fund was used for qualified higher education expenses associated with a qualified tuition program. Robert, the child who did not attend college, never received anything. Therefore, there is no effect on his gross income. Arthur must recognize $6,100 of interest income for the amount refunded. pp. 5—31 and 5—32 The tax benefit rule does not result in an increase in Mary’s gross income. The tax benefit rule applies when the taxpayer takes a deduction in one year, but recovers the deduction in a subsequent year. Under the tax benefit rule, income generally must be recognized on the recovery, but only to the extent the taxpayer received a tax benefit from the deduction in the prior tax year. Instead, Mary’s problem relates to income received in the wrong tax year, which must be recognized in the year received, regardless of when it was earned. Thus, Mary reports the $5,400 in 2003 and the $1,000 in 2009 when she receives it. p. 5—31 No. If the mortgage was held by the seller, Harry would not recognize income but would reduce his basis in the residence, regardless of his financial circumstances. Because Harry is experiencing financial difficulties, he can exclude the income and reduce his basis in his property for the income from discharge of indebtedness on his personal residence. pp. 5—33 and 5-34 Harry needs to identify and resolve the f0110wing issues: 0 ls the friend forgiving the debt as a gift to Harry? I Did the mortgage holder sell the property to Harry? o 15 Harry insolvent or undergoing bankruptcy proceedings? o Is the debt secured by his personal residence? a If Harry must recognize income from the debt cancellation, does he have losses to offset? 0 May Harry reduce the basis of the asset rather than recognizing income? p. 5-34 PROBLEMS 28. 29. The $50,000 in medical bills paid by Ed’s employer cannot qualify as a nontaxable gift. (However, medical expenses subject to the 7.5% floor may qualify as an itetitiZed deduction for Ed.) The $10,000 received from the general public is an excludiblc gift. The $12,000 that Ed’s widow received in her "time of need” may be excluded from gross income if the company has a general policy of making such payments. Otherwise, the IRS may challenge the payment as a taxable payment for Ed’s prior services. The life insurance proceeds are excluded from gross income since they were paid to the beneficiary of the life insurance policy. pp. 5-4 to 5-7 and Chapter 14 a. The $4,000 in accrued salary and the $2,500 of vacation pay earned by Jose but received by his daughter must be included in her gross income in the tax year she receives it. Such income that has been earned, but not received, at the time of the decedent’s death is income in respect ofa decedent. 30. 2009 Individual Volume/Solutions Manual Although the employer may have altruistic motives, because Josh is an employee, the payments cannot be treated as gifts for income tax purposes. Therefore, Josh must include the $1,500 in his gross income. However, if the employer expected to be repaid when Josh is able to work. the payments could be treated as a loan. Jay’s wife does not recognize income from the receipt of $10,000, since the proceeds are from life insurance and are payable to her as the result of Jay’s death. The mortgage holder received the proceeds from a policy as a result of a transaction for consideration. The mortgage holder must recognize gain if its basis (unrecovered amount ofthe loan) in the mortgage is less than $40,000. Lavender, Inc. is the beneficiary of a life insurance policy it purchased and whose proceeds were paid upon the death of the insured. "l‘herefore. the pl‘OceedS are excluded from its gross income. When Rex dies, Jackson will receive the life insurance proceeds of $75,000. Normally the $75,000 would be excludible from Jackson‘s gross income because the life insurance proceeds are payable as the result of death. However, since Jackson acquired the life insurance policy in exchange for valuable consideration, the exclusion treatment does not apply. So Jackson must include in his gross income the $75,000 life insurance proceeds reduced by the sum of $45,000 and the life insurance premiums that he pays. pp. 5—4 to 54% The sale of the stock by Laura will result in a $15,000 ($50,000 amount realized — $35,000 adjusted basis) capital gain. However, Laura’s capital gain rate may be 0% if she is in the 10% or 15% marginal tax brackets. If she is in the 25% or greater marginal tax brackets, her alternative tax rate will be 15%. So her tax liability on the $15,000 capital gain could be either $2,250 ($15,000 X l5%) or $0 ($15,000 X 0%). 1f Laura is diagnOSed as “terminally ill," the realized gain on the life insurance policy of $20,000 ($50,000 —— $30,000) is excluded from her gross income. Capital gain treatment would apply to the sale of the stock by Laura’s mother. The $20,000 realized gain on the life insurance policy will be included in the gross income of" Laura’s mother. Laura’s mother cannot qualify for the exclusion because she is not terminally ill. The mother‘s recognized gain of $20,000 will not be eligible for capital gain treatment because cashing in the life insurance policy is not considered a “sale or exchange,” which is a requisite for capital gain treatment. Regardless of how the medical bills are financed, Laura‘s mother will he allowed to take an itemized deduction for the medical expenses paid (less the 2.5% floor) for her dependent daughter assuming she itemizes her deductions. pp. 5—? and 5—8 Kara must include in gross income the $8,000 of tips. She may be able to exclude the $9,000 value of the free housing provided by her employer as a no~additional—cost service. The living expenses paid by the Federal government are excluded from gross income under § 139 as qualified disaster payments. pp. 5-20 and 5-21 Gross Income: Exclusions 5-9 32. Darlene‘s gross income in 2008 from these transactions is $8,000 associated with the Installment payment from the $200,000 life insurance policy. Of the $28,000 payment she received in 2008, $20,000 is a return of capital and $8,000 is included in her gross income. Her basis for the life insurance proceeds left with the insurance company is $200,000. The return of capital portion is calculated as follows: $200 000 $280,000 X $28,000 = $20,000 All of the life insurance proceeds ($180,000 and $200,000) are excluded from her gross income. Likewise, the $80,000 of workers’ compensation received is excluded from her gross income. pp. 56, 5-7, 5-13, and Chapter 4 33. a. Fay is the beneficiary of the life insurance policy and can exclude the proceeds of $1.75 million from her gross income. b. The $20,000 of interest earned on the life insurance proceeds Eeft with the insurance company is included in Fay’s gross income. c. Fay did not recognize a gain on the bargain purchase. Fay simply get a good price on the purchase under an arm’s length contract. pp. 5-6 to 5-8 34. a. The $17,000 received for tuition, fees, books, and supplies can be excluded from Sally’s gross income as a scholarship. The $2,500 received for room and board must be included in her gross income. The athletic scholarship is considered a payment to further the recipient’s education and is not compensation for services. b. The “scholarship” is additional compensation to Willy’s father. The fact that the “scholarships” are only awarded to the children of executives indicates that the employer is not simply making payments to assist the student seeking his or her education, but rather to compensate an employee. pp. 5-9 and 5-10 35. Alejandro recoived a total of $11,000 and spent $8,900 ($3,300 + $3,400 + $1,000 + $1,200) on tuition, books, and supplies. The amount received for room and board is not excludible. Therefore, he must include $2,100 ($11,000 — $8,900) in gross income. When he received the money in 2008, Alejandro’s total expenses for the period covered by the scholarship were not known. Therefore, he is allowed to defer reporting the income until 2009, when all the uncertainty is resolved. pp. 5-9 and 5—10 36. a. Leigh must include in gross income the punitive damages of $50,000. The other amounts ($15,000 and $8,000) may be excluded as arising out of the physical injury, except the $1,000 amount received for damage to her automobile. This amount is a nontaxable recovery of capital (i.e., it reduces her basis for the aut0mobi1e by $1,000). b. The $40,000 is included in Leigh’s gross income because it did not arise out of a physical personal injury. pp. 5—11 and 5-12 2009 Individual Volu meiSolutions Manual 3. The settlement in the sex discrimination case did not arise out of physical perSOnal injury or sickness. Therefore, the $150,000 is included in Eloise’s gross income. 1). The damages to Nell‘s personal reputation are not for physical personal injury or sickness. Therefore, Nell must include the $10,000 in her gross ineorne. She must also include the $40,000 punitive damages in her gross income. c. The damages of $50,000 are included in Orange Corporation’s gross income under the tax benefit rule, assuming the company received tax benefit from deducting the audit fees in a previous year. d. The compensatory damages of $10,000 for the physical personal injury are not included in Beth's gross income, but the punitive damages of $30,000 must be included in her gross income. e. Since the compensatory damages of $75,000 arose from a physical personal injury. they are excluded from loanne’s gross income. The punitive damages of $300,000 are included in her gross income. pp. 5-11, 5-12, and 5—32 Rex is required to include in gross income the $4,500 received from the wage continuation policy while he was ill. This amount is included in gross income only because the employer paid for the policy. The other items can be excluded from gross income. pp- 5-13 to 5-15 Hoffman. Smith, and Willis, CPAs 5191 Natorp Boulevard Mason, OH 45040 September 27, 2008 UVW Union 905 Spruce Street Washington, DC. 20227 Dear Union Members: You asked me to explain the tax consequences of HON Corporation’s propOSed changes in the employees’ compensation package. The proposed changes include (1) the imposition of a $100 deductible clause in the medical benefits plan, (2) an additional paid holiday, and (3) a cafeteria plan that would allow the employee to receive cash rather than medical insurance. The deductible clause will cost each employee $100 after tax. That is, the employee will be required to pay an additional $100 for the same medical benefits that the employee presently receives and, generally, none of the $100 will be deductible in arriving at taxable income. The additionai paid holiday will have no effect on after-tax income—the employee‘s annual gross income will not change. The cafeteria plan will mean that some empioyees who now have excess medical coverage can substitute cash for the unneeded protection. The cash received will be taxable, but the employee‘s after-tax income will increase. 40. 41. 42. Gross Income: Exclusions 5—1] In summary, the change with the broadest tax implications is the imposition of the $100 deductible for medical benefits. The employees would actually be better off with a $100 reduction in cash compensation and no deductible clause. This results because the after~tax cost ofa $l00 reduction in cash compensation is only $"r'2 [(1 — .28) ($100)], whereas the $ I 00 deductible clause means the employee has 3100 less for other goods and services. Also, the cafeteria plan may be important for some employees, depending upon how many of them have working spouses whose employers provided medical benefits for the employee’s entire family. Please contact me if you have any further questions. Sincerely yours, John J. Jones, CPA Partner pp. 5—13 to S-lS and 5-19 With a medical reimbursement plan, Mauve would be paying all ofthe employee’s medical expenses. The employee would have no incentive to control costs. With the flexible benefit plan, the employee must contribute to the costs through a salary reduction under the flexible benefit plan. Therefore, for this plan the employee has an incentive to minimize costs. pp. 5-14, 5—15, and 5—l9 Bertha must include $800 ($9,800 - $9,000) in her gross income for the long-term care insurance she received. The charges by the nursing home were less than the maximum exclusion (SZTO per day). The potential exclusion is the greater of the following: 0 $270 indexed amount for each day the patient receives the long—term care. 0 The actual cost of the long-term care. Therefore, the amount excluded from her gross income is the statutory indexed amount (3270 X 60 days = $16,200) [the cost of the long-term care of $12,000 is less] reduced by the Medicare payments. Thus, the exclusion is $9,000 ($16,200 -— $71,200). p. 5-15 The concern in this situation for Tim is that the house will not be considered “on the employer's premises" in order for Tim to qualify for the meal and lodging exclusion. However, Tim could effectively argue that the house is an extension of the employer‘s office because of the extensive business activities (communications, entertaining) conducted in the house. He should be prepared to document the extent of business activities conducted at the house. The presence of an administrative assistant would suggest that much more than incidental business activities are conducted in the home. Gross income would include 8130 ($350 v $220) per month because the benefit exceeds the qualified parking monthly exclusion limit of $220. pp. 5-15 to 5-17 and 5-23 a. It appears that Ann’s meals are not provided for the convenience of the employer, but rather as a fringe benefit for the employees. Therefore, Ann is required to include in gross income the difference between the amount she paid for meals of $3 and the amount she would be required to pay of $8 to an unrelated restaurant. 44. 45. 2009 Individual Volume/Solutions Manual b. The monthly salary of $200 must be included in gross income. The dormitory room provider Ira is done so for the convenience of his employer. Therefore, Ira can exclude the $250 value per month of the free lodging from gross income. e. Apparently Seth is not being provided the housing for the convenience of his employer. Therefore, the fair rental value of the housing must be included in Seth’s gross income. pp. 5-15 to 5—]? Only Betty can decide whether she should take early retirement. However, as an aid in making her ClCClSlOI’l, you can inform her that her disposable income after the effect of the medical insurance and health club dues will decrease by approximately $828 per month. Now Beam—d Salaryfretirement $40,000 $24,000 Part-time job —0— 1 1,000 Social Security tax (3,060) (842) Income tax (.25) (10,000) (8,250) Medical insurance —O-— (2,800) Heaith club dues —0— (600) MEL). Disposal income associated with employment $26,940 Less: Disposable income associated with retirement 1 17,0081 Decrease in disposable income (£9,932; pp. 5—13, 5—14, and 5-18 Hoffman, Smith, and Willis, CPAs 5191 Natorp Boulevard Mason, 01-1 45040 September 18, 2008 Finch Construction Company 300 Harbor Drive Vermillion, SD 52069 Dear Management: You asked me to determine the tax implications of requiring the company's employees who are carpenters to furnish their own tools, with a compensating increase in their salaries of about $1,500 each. In short, most employees would experience a net decrease in after— tax income. Under the company’s present way of doing business, the carpenters do not recognize income when the employer provides tools. This is a “working condition fringe.” If the employee’s salary is increased and he or she must purchase the necessary tools, the employee must include the additional $1,500 in salary in gross income. But the cost of the tools in many cases will not be deductible, or less than the actual cost will be deductible. This results from the employee’s expense being a deduction from adj usted gross income as a miscellaneous itemized deduction. If the employee takes the standard deduction. no deduction for the tool expenses is allowed. If the taxpayer does itemize deductions, the 46. Gross Income: Exclusions 5-13 total miscellaneous itemized deductions must be reduced by 2% of the employee’s adjusted gross income. In many cases, the total miscellaneous itemized deductions will be less than 2% of AGI. When the total miscellaneous itemized deductions do exceed 2% of AG]. less than the entire expenses are deductible because of the 2% factor. Another possibility would be for the employees to purchase the tools, but account to you for their cost, and obtain reimbursement. Under this plan, the employee would be allowed to directly offset the reimbursement with the expense, in atriving at adjusted gross income. The request for reimbursement would also provide you with a means of controlling costs. Please contact me ifyou Would like to discuss this further. Sincerely. Amy Evans, CPA Partner p. 5.22 a. Employer’s before-tax compensation equivalent to $7,000 exempt compensation: Jon; _M iddle l_lig11_ income groups Benefits $7.000 $7,000 5 1000 Income tax rate 0.15 0.25 0.35 Social Security and Medicare tax rate 911765 0.0765_ 0:01.43: Total marginal tax rate (MTR) 0 2265 (Lilo; 0._3_6_€l_5_ l —- MTR 7735 6735 .6355 Before tax compensation = |$?,000 *1- (l — MTRH $9,050 5 l0‘593 $1 1,01 5 b. Employer’s cost of before—tax compensation: equivalent to $1000 exempt compensation: Before tax compensation = $9,050 $10,393 Si [,015 Employers Social Security tax 692 7’95 _ 160 $9342 $1l,188 $11.1.75 Less: reduced income tax (.35) Liam 13,916) 41,971 [1 Employer‘s after-tax cost of taxable Compensation spies; 5:21.13; fi....?___.;=f_t§l c. Exempt compensation $1000 $ 1000 S 1000 Less: Reduction in income tax (.35) $2141) _[2,_450} _f_2 450] Employer’s after-tax cost oftax— exempt benefits E. él._§_§_l!__. 25 4,550 d. For an after-tax cost oi"$4._550 per employee, Redhird can provide tax—exempt benefits to its employees that are equivalent to before—tax taxable compensation of $9,050. $10,393, and 9511015, respectively, depending on the employee’s marginal tax bracket. it would cost the company $6,332, $132, and $71,264, respectively, to provide the taxable compensation equivalent of $1000 tax-exempt income. Both the employer and the employee benefit from the exemption. Note. however. that if an employee is already covered in a similar medical benefit plan under a spouse‘s plan that the employee may want the cash compensation. pp. 5-13 and 5-14 5—14 47. 48. 49. 2009 Individual Volume/Solutions Manual lfRosa underfunds the account by $2,000. the cost of the error is her marginal tax rate times the underfunded amount or $5 00 (.25 >< $2.000). b. It‘ Rosa ox-‘ert‘unds the account by $2,000, the cost ofthe error is $1,500 [(1 —— .25} X 32,000]. it. The cost ol‘ underl‘uttding is a .25 X error. and the cost of" overfunding is a .i’5 X {I —- .25) error; that is, the under-funding error costs only one-third (.251’5’5) the cost of overfunding. d. Rosa should fund the flexible benefit account using an amount closer to the low end of the estimate rather than to the upper end. p. 5-20 Polly is both an employee and a controlling shareholder in the corporation. Therefore, benefits she receives that are not excludibie from gross income may be characterized as a dividend. This would mean that she might enjoy the lower tax rate applicable to dividends as compared to compensation; however, the corporation will not be allowed to deduct any amount that is considered a dividend. a. (1; The $1,500 cost ol'thc retirement planning seminar can be excluded from Polly’s gross income since it is provided on a nondiscriminatory basis. p. 5-24 Employee parking is specifically excluded from gross income. However, the value of Polly’s free parking Ol‘ $2300 (52300312 = $225 per month) exceeds the permitted exclusion amount of $2,640 ($2.640il2 = $220 per month). Note that parking can be provided on a discriminatory hasis. p. 5-23 The use of the phone is excluded from Polly‘s gross income as a no—additionahcost benefit. It also may lit the requirements For a de minimis fringe benefit. pp. 5-21 and 5-23 The value of the use of the condominium is a no-additional-cost fringe benefit that Polly can exclude from gross income. p. 5-21 The freight: is a no—additional-cost benefit made available to all employees (nondiscriminatory). The 5750 can be excluded from Polly's gross income. p. 5-21 The plan is discriminatory. Therelore. the highly compensated employees must pay tax on all ol‘ their discounts. Polly includes $900 in her gross income. pp. 5-2 1, 5-22 and 5-24 For the 12-month period ending May 31, 2009, George satisfies the 330-day requirement {i.e., was in London and Paris for 365 days). Therefore. he qualifies for the foreign earned income exclusion treatment for this period which includes 214 days in .2008. For 2008. George can exclude the following amount from his gross income: Ejsdaxs 365 days *Lowcr of earned income of $230,000 or indexed statutory ceiling of $87,600 for 2008. George must include $178,640 ($230,000— $51,360) in his gross income for 2008. x $81600“ $5i.360 50. SI. 52- Gross Income: Exclusions 5-1; For the 12-month period ending December 31, 2009. George satisfies the 33tt-day requirement (i.e., was in London and Paris for 365 days). Therefore. he qualifies for the foreign earned income exclusion treatment for this period ‘t-vhieh includes 365 days in 2009. For 2009, George can exclude the following amount from his gross income: 365 days 365 days X 58?,600 ofsalary = $87,600 *Lower of canted income of $275,000 or indexed statutory ceiling of 381600 for 2009. George must include $18?,400 ($275,000 — $871,600) in his 2009 gross income. pp. 5—25 to 5-2? l-lazel must include all of the items in gross income. except the interest received of$900 on Augusta County bonds. The patronage dividend is included in gross income under the tax benefit rule because the dividend is a recovery of costs deducted in a prior year. All other items are simply gross income not otherwise excluded. Therefore, Ilazel must include in gross income $2,650 ($600 + $300 + $150 + $1,600). pp. 5-28. 5-29. and 5—32 a. Ezra must include in his gross income the $700 cash he constructively received. He will have a $?00 basis in the additional shares he received. The decrease in the value ofthc fund shares 01‘ $1,200 ($15,700 — $14,500) is not taken into aceount because he has not realized (e.g., from a sale or exchange) the loss. Ezra received stock dividends, which are essentially more shares to represent his same reiative interest in the corporation. Because his interest in the corporation did not change, and he did not have the option of receiving cash, Ezra has no gross income from the receipt of dthe stock dividends. Ezra must allocate his original cost of his Giant, lnc., shares among the original shares owned and the additional shares received as a nontaxable stock dividend. pp. 5-29 and 5—30 The corporate bond has the greatest alter-tax yield. The alter-tax yields are as follows: Virginia bond = 4% Corporate bond = 5.2% (1 — .15 — .05)(6.5) U.S. Government bond - 5.1% (l — .15')(.0o) The Virginia bond is subject to neither Virginia nor Federal income tax. The corporate bond is subject to both Federal and Virginia income tax. The US. Government bond is subject to Federal income tax. but is not subject to state income tax. pp. 5-23 and 5-29 5-16 2009 Individual Volume/Solutions Manual Hoffman, Smith, and Willis, CPAs 5l91 Natorp Boulevard Mason, OH 45040 September 7', 2008 Ms. Lynn Schwartz 100 Myrtle Cove Fairfield, CT 06432 Dear Lynn: You asked me to consider the tax-favored Options for accumulating the funds for Eric’s college education. An added complication (and opportunity for tax planning) in your case is that the funds will come from your parents who are in a much higher tax bracket than either you or Eric. Various options are discussed below. Within some of the options, there are sub—options available; that is, your parents could give the funds to you or to Eric before the investments are made. 0 Your parents could purchase stock certificates, bonds, certificates of deposit, or other investments in Eric's name with them as custodian. The first $850 of the income (after subtracting an $850 standard deduction) would be subject to Eric’s marginal tax rate. Income above that would be taxed at your marginal tax rate. This Option provides the maximum flexibility while removing the income from your parents’ high marginal tax bracket. - Your parents could buy taxwexcmpt bonds and accumulate the interest, which is excludible from gross income. However, the rate of return on the investment may be much lower than could be obtained with taxable options. ' Your parents may give the $4,000 a year to you and you could purchase Series bonds in your name and use the proceeds to pay Eric’s educational expenses. No tax will be due on the interest. This option would not be available if your parents purchased the bonds because the exemption is not available to taxpayers in your parent’s income class. That is. the potential exclusion would be completely phased out for your parents. - Your parents could invest the funds in Connecticut’s Qualified Tuition Program. This program provides a hedge against inflation in tuition cost, but little or no other return on the investment. The earnings of the fund, including the tuition savings, will not be included in gross income provided the contribution and earnings are used for qualified education expenses. If] can be of further assistance in helping you to make this decision and explain the options to your parents, please call me. Sincerely your, John J. Jones, CPA Partner pp. 5-30 to 5-32 54. 55. 56. Gross Income: Exclusions 5-17 The savings bonds qualify as educational savings bonds. The savings bonds were issued to Chuck and Luane who were at least 24 years of age (actually older) and the savings bonds were issued after 1989. Paying the tuition and fees ($8,000) for Susie, their dependent, qualifies as higher education expenses. The room and board of $4,000 does not qualify. Since the redemption amount ($12,000) exceeds the $8,000 of qualified higher education expenses, only part of the interest qualifies for exclusion treatment as follows: $5,000 X ($8,000 “2* $12,000) = $3,333 Since their modified adjusted gross income (MAGI) of $103,000 exceeds the threshold amount of$100,650 for 2008, part ofthe potential exclusion is phased out. MAG] $103,000 Less: Threshold amount (100,650) Excess over threshold amount 3_ 2,150,, The amount of the potential exclusion that is phased out is as follows: $3,333 a ($2,350 *1“ $30,000) = $261 Thus, Chuck and Luanc can exclude $3,072 ($3,333 — $261) of the savings bond interest received and $1,928 ($5,000 — $3,072) must be included in their gross income. All of the $5,000 of savings bond interest must be included in Susie’s gross income. The educational savings bond exclusion under § l35 applies only if the savings bonds are issued to an individual who is at least age 24 at the time of issuance. if Chuck and Luane file separate returns, they do not qualify for exclusion treatment under § 135. Thus, they must include the $5,000 of savings bond interest in their gross income. pp. 5-29 and 531 The Qualified Tuition Program is the slightly preferable investment in terms of return on investment. The compounded value of the bond fund at the end of the 8 years is expected to be $5,260 ($4,000 8 1.44). The Qualified Tuition Program will pay $6,000 for the son‘s tuition, and the son does not include anything in his gross income. Thus, the aficr~tax proceeds will be $6,000. it should be noted that the Qualified Tuition Program also provides a hedge against even greater possible increases in tuition. pp. 5-31 and 532 8. Lemon Furniture must include $1,000 in gross income as the recovery of a prior deduction which produced a tax benefit. Marvin must include $4,000 of the refund in his gross income for 2008 because he received a tax benefit for the deduction in 200?. The other $200 of the refund is not included in his gross income because it did not produce a tax benefit. Barb must include $5,000 in her 2008 gross income, the amount of the reduction in taxable income from the medical expenses paid in 200?. T he remainder of the amount received can be excluded as resulting from a personal physical in] ury. p. 5-32 5-18 57. 58. 2009 Individual Volume/Solutions Manual If Fran retires the debt on the residence, she must recognize $20,000 as income from discharge of indebtedness. She would be required to pay $7,000 ($20,000 X 359%) of additional income tax in the year the debt is retired. Thus, she must pay $2,000 to reduce future after-tax interest expense of 5.2% [(1 — .35) (08)] of the outstanding principal and to retain the other $20,000 that would otherwise be paid as principal on the debt. This alternative yields the same result as a., except Fran can choose to reduce her basis in the business assets instead of recognizing $20,000 income, assuming the liability is qualified business indebtedness. The basis reduction is, in effect, a deferral of the tax (that will be paid when the asset is sold or as depreciation deductions are reduced). Fran should retire the mortgage on the business property and thus defer the tax on the $20,000 gain. pp. 5—33 and 5-34 a. b. Father’s admonishment clearly indicates that he is making a gift to Robin. 'l‘herefore, Robin does not include the $10,000 in his gross income. The corporationis cancellation of the $6,000 debt is income from discharge of indebtedness to Robin. (Note that if the debt was not actually cancelled, but Robin never attempted to pay it, the 1R8 would treat the loan as a dividend.) The $12,000 reduction in the debt owed to the seller (Trust Land Company) is not included in Robin’s gross inconie. instead, his basis in the land must be reduced by the amount of the debt cancelled. Robin must include $4,000 in gross income from the cancellation of the $4,000 liability for accrued interest. This is a recovery of a prior deduction and is subject to the tax benefit rule. pp. 5-33 to 5-34 CU MULATIVE PROBLEMS Taxable income Gross income Salary ($100,000 + $40,000) $140,000 Group term life insurance (Note l) 180 Dividends 1,500 State tax refund { Note 2} 1,600 $143,280 Deductionsfor adjusted gross income Alimony paid (Note 3) g 12.0001 Adjusted gross income $131,280 itemized deductions State income taxes ($3,400 + 82,300) (Note 4) 55,700 Home mortgage interest 4,800 Real estate taxes 1,450 Cash contributions 1,200 (13,150} Personal and dependency exemptions (53,400 X 2) £6,800: $.11 ,330 ...
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Ch. 5 Answers - Question} Problem 4'}..me OOH-JGNUI ll 12...

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