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Employee Compensation and Retirement Plans
Solutions to Problem Materials DISCUSSION QUESTIONS
18-1 Yes. The dentist must recognize gross compensation income in an amount equal to the fair market value of the service received by the dentist (i.e., the preparation of his tax return). Compensation payments may be made in a medium other than cash. (See p. 18-2 and Reg. 1.61-2(d)(1).) A fringe benefit may be defined as an indirect and often noncash compensatory payment to an individual that in some manner improves the individual's economic position. Fringe benefits are included in gross income unless specifically excludable by statute. (See pp. 18-2 and 18-3 and 132.) The value of a Christmas turkey or ham is excludable from gross income as a "de minimis fringe benefit" under 132(e) because the value is so small as to make accounting for it administratively impractical. However, a Christmas bonus of $500 cash is not excludable under 132, and is therefore includible in gross income under 61. (See p. 18-3 and Chapter 6.) A cafeteria plan is a package of employee fringe benefits, both taxable and nontaxable, from which employees may choose the benefit or benefits most attractive to them. [See p. 18-3 and 125(c).] The receipt of shares of stock or stock options by a corporate employee transforms the employee into an owner of the business and, theoretically, strengthens that employee's commitment to the corporation and its future growth. (See p. 18-34.) The taxpayer must consider the immediate tax effect of the current gross income recognition required by the 83(b) election. He also must assess the likelihood that he will have to forfeit the restricted property in the future, in which case the election would be a costly mistake. Finally, the taxpayer must predict the increase in the value of the restricted property during the restriction period; the greater the predicted increase, the greater the value of the 83(b) election. (See pp. 18-4 through 18-6.) Upon exercise of an ISO, the differential between the exercise price and the market price (the bargain element) escapes taxation as ordinary compensation income, and is taxed as capital gain only upon future sale of the stock. [See Example 30, p. 18-35 and 421(a).] An employee would normally prefer a funded retirement plan because of the security offered by the funds themselves. The employer, however, would prefer not to have to tie up cash or other business assets to secure an employee retirement plan. (See pp. 18-33 and 18-34.) 18-2 18-3 18-4 18-5 18-6 18-7 18-8 18-1 18-2 Chapter 18 Employee Compensation and Retirement Plans 18-9 A cash basis taxpayer recognizes income upon receipt of payment, regardless of when the income was earned or the perfected right of the taxpayer to payment. Thus, if a cash basis taxpayer has earned the right to receive compensation at some future date, but has no current right to payment, he is not in constructive receipt of the deferred compensation. [See pp. 18-31 through 18-33 and Reg. 1.451-2(a).] There are two major tax advantages granted to qualified retirement plans. First, the employer's contribution to the plan is not taxed to the employee in the year the contribution is made. Secondly, the earnings of the plan are not taxed until withdrawn by the employee. [See Exhibit 18.2, pp. 18-6 and 18-7, and 402(a) and 501(a).] Under a defined benefit plan, annual contributions are determined actuarially, based upon a specified amount (benefit) that each employee is entitled to receive upon retirement. Under a defined contribution plan, the annual contribution itself is specified, usually in terms of a percentage of current profits. [See p. 18-10 and Reg. 1.401-1(a).] No. (See the discussion of plan participation requirements on pp. 18-14 and 18-15 and 410.) Vesting refers to an employee's nonforfeitable right to the amount of contributions made on his behalf to a qualified retirement plan. (See p. 18-15 and 411.) Participation refers to an employee's right to have his employer make contributions on his behalf to the qualified plan. (See pp. 18-14 and 18-15, and 410.) Employer contributions to a profit-sharing plan are discretionary and generally made only in a year in which the corporate business is profitable. Participation in a profit-sharing rather than a pension plan may encourage employee productivity. (See p. 18-11.) A taxpayer who works in the home rather than in the market place for a wage or salary has no "earned income" on which to base a contribution to an IRA. Therefore, retirement protection for such taxpayer may be provided by reference to the "earned income" of that taxpayer's spouse by means of a spousal IRA. (See Examples 19, 20 and 21, p. 18-40 and 219(c).) If a lump-sum distribution out of a qualified plan is not rolled over into an IRA, the distribution is subject to current taxation. Formerly, a rollover would prevent utilization of five-year forward averaging when the money is distributed out of the IRA. [See pp. 18-7 and 18-8, and 402(a)(5) and 408(d)(1).] a. Traditional as well as Roth IRA contributions are allowable up to $5,000 per year per person in 2011. Under certain circumstances, traditional IRAs can be deductible while Roth IRAs are never deductible. Distributions from Roth IRAs are not taxable if certain qualification requirements are met. Traditional IRAs are always taxable when distributed to the extent they exceed any basis. In addition, taxpayers are not required to begin taking mandatory distributions at the age of 70 with a Roth IRA like they are with a traditional IRA. ((See pp. 18-22 and 18-26.) A Roth IRA may be preferred for certain retired persons who do not wish to take a mandatory withdrawal at the age of 70. In addition, the Roth IRA might be better suited for a young couple that wants to begin putting money aside yet needs access to the original contribution if the case arises (i.e., to buy a new house or family emergency). A traditional IRA might be wise for someone that is entitled to a deduction for the $5,000. In this manner, they can use a tax refund they receive from the deduction to help fund the IRA. (See p. 18-29.) An educational IRA allows a taxpayer to make a nondeductible contribution of up to $2,000 per year for each beneficiary under the age of 18. The IRA is a trust that is established to pay the higher education costs of the beneficiary. Withdrawals from an education IRA are only excludable to the extent that they are used for the education expenses. (See pp. 18-29 and 18-30.) No contribution can be made by anyone to an education IRA during any year in which contributions are made to a qualified prepaid tuition program for the same beneficiary. In any year in which an exclusion is claimed by a beneficiary for a distribution from an education IRA, no Hope credit or Lifetime Learning credit may be claimed with respect to education expenses. (See p. 18-29.) 18-10 18-11 18-12 18-13 18-14 18-15 18-16 18-17 b. 18-18 a. b. Solutions to Problem Materials 18-3 PROBLEMS
18-19 a. b. c. 18-20 a. b. c. 18-21 a. b. c. 18-22 2011--No income because of the substantial risk of forfeiture 2014--$10,000 [See Example 1, pp. 18-4 and 18-5, and 83(a).] 2011--$3,500, the current value of the restricted stock 2014--No income [See Example 3, pp. 18-5 and 18-6, and 83(b).] a. $10,000 in 2014 b. $3,500 in 2011 [See Example 1 and Example 2, pp. 18-4 through 18-6, and 83(h).] 2011--The $200 value of the option must be included in gross income. [See Example 3, pp. 18-5 and 18-6, and Reg. 1.83-7(b)(1).] 2013--No further income is recognized upon exercise. [See pp. 18-5 and 18-6 and Reg. 1.83-7(a).] The deduction available to Corporation Z is $200, to be taken in 2011, the year the option is granted. [See pp. 18-5 and 18-6, and 83(h).] No income is recognized on receipt because the options have no ascertainable value. (See Example 3 and pp. 18-5 and 18-6.) $28,000 ordinary income--This is the bargain element of $28 1,000 shares. (See Example 2 and pp. 18-4 and 18-5.) The deduction available to X Corporation is $28,000 (the compensation element to E), to be taken in 2011, the year the option is exercised. [See pp. 18-4 and 18-5, and 83(h).] In Problem 18-20, the employee has a $2,200 basis in the stock--the $200 basis in the option plus the $2,000 option price paid for the stock. In Problem 18-21, if employee has a $48,000 basis in the stock--the $28,000 income recognized upon exercise plus the $20,000 option price paid for the stock. [See Reg. 1.61-2(d)(2)(I).] No income is recognized in 2012. [See Example 30, p. 18-35, and 421(a)(1).] a. b. No income is recognized on exercise. [See Example 30, p. 18-35, and 421(a)(1).] $19,500 (6,000) $13,500 18-23 18-24 Selling price Basis in shares ($120 cost 50 shares) Capital gain recognized 11- (See Example 30 and p. 18-35.) 18-25 Selling price Basis Gain ($4,500 is ordinary) $4,500 is bargain element upon exercise [See Example 31, p. 18-38, and 421(b).] Selling price Basis Ordinary income (See Example 31 and p. 18-35.) $12,500 (6,000) $ 6,500 $9,500 (6,000) $3,500 18-4 Chapter 18 Employee Compensation and Retirement Plans 18-26 a. b. $75,000 [100% taxable per 402(a).] Computation per 402(e): Tax on lump-sum distribution: Total distribution Less: Minimum distribution Less: allowance* Amount previously subject to five-year averaging $75,000 (0) $75,000 *Five-year averaging has been repealed, thus the computation is not necessary. The problem simply demonstrates the amount that would have been eligible for averaging. 18-27 Total distribution Less: Minimum distribution allowance* Amount subject to five-year averaging $51,000 (3,800) $47,200 *Five-year averaging has been repealed, thus the computation is not necessary. The problem simply demonstrates the amount that would have been eligible for averaging. 18-28 18-29 $195,000 in 2011. [See Exhibit 18-3; pp. 18-16 and 18-10, and 415(b)(1).) A contribution to a qualified plan may be computed only on an employee's first $245,000 (in 2011) of compensation. Therefore, the maximum contribution to Mr. W's retirement account is $70,000. Note this contribution is limited to 100 percent of compensation or $49,000 limitation in 2011. (See Exhibit 18.3, Examples 10 and 11, pp. 18-15 through 18-17, and 401(a)(17).) Total amount distributed Less: Income tax at 31% 10% premature withdrawal penalty 15% on excess distribution Net after-tax distribution $300,000 (93,000) (30,000) (7,500)* $169,500 18-30 *15% on excess distribution of $150,000 less $15,000 (the premature withdrawal penalty on the excess distribution). [See pp. 18-8 and 18-9 and 72(t) and 4980A(a) and (b).] 18-31 18-32 H may contribute and deduct $45,000 in 2011--the lesser of $49,000 or 100 percent of H's earned income-- to a defined contribution Keogh plan. [See Example 12, p. 18-19, and 415(c)(3)(B).] a. b. 18-33 Both H and W may contribute the maximum $5,000 (2011). However, not all of W's contributions is deductible because the excess adjusted gross income ($87,000) exceeds the applicable dollar amount ($83,000). H can deduct $5,000. [See pp. 18-21 through 18-23 and 219(b) and (g).] $10,000. Both H and W may contribute and deduct the maximum amount (i.e., $5,000). [See pp. 18-22 through 18-24 and 219(b) and (g).] Although Ms. A is an active participant in a qualified plan, the deductibility of her IRA contribution will not be limited. The deductible portion of the contribution for 2011 is $5,000 [$5,000 (($29,640 $52,000)/ $10,000 0% $5,000 $0 reduction)]. [See p. 18-24 and 219(g).] Solutions to Problem Materials 18-5 18-34 The excludable portion of the withdrawal is computed as follows: $13,400 nondeductible contributions 29.5% $36,555 year-end balance + $8,800 withdrawal $8,800 withdrawal 29.5% $2,596 excludable amount Therefore, B must include $6,204 in current-year gross income ($8,800 $2,596). [See Example 23, p. 18-26, and 408(d).] 18-35 a. b. Per 402(h)(2), the limit on an employer's contribution to a SEP is the lesser of $49,000 or 25 percent of the employee's compensation for the year. Therefore, Z's employer could contribute $4,500 (25% $18,000 salary). (See p. 18-31.) Z may make a $5,000 deductible contribution to her IRA. Even though Z is an "active participant," her A.G.I. is less than $52,000. [See p. 18-24 and 219(g)(5)(A)(v).] TAX RESEARCH PROBLEMS
Solutions to the Tax Research Problems (18-3618-37) are contained in the Instructor's Resource Guide and Test Bank for 2012. ...
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This note was uploaded on 02/05/2012 for the course ACCT 110 taught by Professor Smith during the Spring '11 term at Adrian College.
- Spring '11