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Unformatted text preview: * C HAPTER S IX * GROSS INCOME: INCLUSIONS AND EXCLUSIONS SOLUTIONS TO PROBLEM MATERIALS DISCUSSION QUESTIONS 6-1 a. False. Receipts are included in gross income unless specifically listed as excludable. [See p. 6-1 and 61(a).] It is the taxpayers responsibility to prove that a particular type of income is excluded and to cite the specific authority providing the exclusions. b. False. Tax returns show that (1) gross receipts except those that are entirely excludable (nontaxable) (2) less excludable portion (3) equals gross income. (See p. 6-1.) Many receipts, such as refunds for state taxes not previously deducted, will not appear on the tax return. c. True. As long as the municipal bond carries tax-exempt status, (i.e., is not an industrial development or arbitrage bond) the interest income is excludable (nontaxable) by individuals and corporations. [See Example 4, p. 6-8 and 103(a)(1).] 6-2 For C to evaluate which investment would produce a greater after-tax return, she must have knowledge of the interest rate of the state bond, estimate the expected rate of return of anticipated dividends from H, Inc., know her marginal tax rate, estimate future proceeds from the sale of the investments, and select a discount rate to determine the present value of the expected future cash flows. (See Example 4 and p. 6-8.) 6-3 a. The after-tax return will be higher if the taxpayer invests in the State of Kentucky bonds. (See Example 4 and p. 6-9.) Corporate Bonds 7% State Bonds 3% Annual interest income Federal income tax35% $ 70.00 (24.50) $ 30 (0) After-tax income $ 45.50 $ 30 After-tax rate of return 4.55% 3.0% b. The after-tax return will be higher if the taxpayer invests in the corporate bonds. Corporate Bonds 7% State Bonds 3% Annual interest income Federal income tax15% $ 70.00 (10.50) $ 30 (0) After-tax income $ 59.50 $ 30 After-tax rate of return 5.95% 3.0% 6-4 A dividend is a distribution paid by a domestic corporation from its current or accumulated earnings and profits. A corporate distribution that is not from current or accumulated earnings and profits generally qualifies as a return of capital. These distributions are treated as a return of investment with the shareholders basis in the stock being reduced. Any distributions in excess of basis are capital gains. Other distributions treated as a return of capital include those from mutual insurance companies on unmatured life insurance policies and patronage dividends to cooperative members. Distributions from regulated investment companies representing gains on investment sales are included as capital gains. [See Example 1, p. 6-5, and 301(c)(3) and 316.] When a stock dividend is distributed with the potential to change the stockholders proportionate ownership interest, it is taxable. Thus, if a choice exists between receiving cash or stock, the dividend is ordinary income. At certain times, a corporation will issue stock dividends to shareholders without giving them an option to receive cash. If the dividend is common or giving them an option to receive cash....
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