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Employee Compensation and Retirement Plans
Solutions to Tax Research Problems
18-36 There are several ways to approach this problem. Here is one: What is the present value at the beginning of Year 11 (beginning of retirement) of each option assuming the amounts of compensation, net of tax, are received at year-end? Current compensation option: Sum of an annuity for 10 years, beginning immediately, of $27,600 (after-tax compensation) at 6.9 percent after tax return ("p-v" stands for present value factor): $27,600 13.7514 p-v $379,538 Deferred compensation option: Present value of a 10-year annuity beginning in 10 years of $34,500 (aftertax deferred compensation) at 6.9 percent after tax return: $34,500 7.0562 p-v $243,438 Given the comparative values of the two options at the beginning of retirement, the current compensation option is superior! 18-37 1. The practitioner should consider advising the taxpayer to adopt an Employee Stock Ownership Plan (ESOP). Setting up an ESOP can accomplish both of the corporation's objectives. The ESOP provides a vehicle for financing working capital or expansion needs. It is also a unique benefit plan in that it allows the employees to become owners of the corporation, thereby increasing loyalty and productivity. Providing stock to the employees through an ESOP would allow them to participate in the company's ownership, profits and future growth. This should provide incentive for employees to remain with the company and increase their productivity. Using an ESOP to finance the purchase of needed capital improvements can conserve working capital in one of two ways. 5- Gills can borrow the $700,000 directly from a lender, repay the lender directly, and make annual contributions to the ESOP in stock of a value equal to the principal payments. The ESOP can borrow the $700,000 and buy newly issued stock valued at $700,000 from Gills. The ESOP would then use annual contributions from Gills to repay the loan with interest, 18-1 18-2 Chapter 18 Employee Compensation and Retirement Plans Assuming total interest of $325,000 and a corporate tax rate of 34%, the aftertax cost of funding the capital improvements and ESOP under the two options would be as follows: Acme Borrows Funds Directly Principal Interest Tax benefit: Interest expense ($325,000 34%) ESOP contribution ($700,000 34%) After-tax cost of funding capital improvements and ESOP $ 700,000 325,000 (110,500) (238,000) $676,500 ESOP Borrows Funds and Purchases Stock from Gills Contributions to ESOP (equal to debt service) Tax benefit ($1,025,000 34%) After-tax cost of funding capital improvements and ESOP $1,025,000 (348,000) $ 676,500 In the case of a leveraged ESOP, the employer contributions used to pay ESOP loan interest are fully deductible and the employer contributions used to repay loan principal are deductible up to 25% of compensation of the participants under 404(a)(9). [Under 404(a)(3) the maximum deduction for a nonleveraged ESOP is 15% of compensation of participants when the ESOP is not combined with a pension plan.] Because Gills' payroll is approximately $600,000, contributions could be as much as $150,000 ($600,000 25%) plus the interest payment. 2. In comparing an ESOP with a pension or profit-sharing plan, an ESOP will produce more working capital because the contribution is made with employer stock rather than cash. The corporation is entitled to a deduction for the contribution and has no corresponding decrease in its cash flow. In this case, the corporation has taxable income of $600,000 before making the $100,000 contribution to its retirement plan. The impact on working capital is shown as follows. Pension or ESOP Profit Sharing Taxable income before contribution $ 600,000 $ 600,000 Contribution (100,000) (100,000) Taxable income after contribution $ 500,000 $ 500,000 Tax (@ 34%) (136,000) (136,000) Add back noncash contribution 100,000 0 Increase in working capital $ 364,000 $ 264,000 Before implementing an ESOP, a company should fully understand the disadvantages that it may face. The following list includes some of the disadvantages that must be considered. a. Under 401(a)(28)(C), the value of stock of a closely held corporation contributed to an ESOP must be determined by an independent appraiser. b. If the stock sold to an ESOP is overvalued, there is a potential for imposition of the rules on prohibited transactions, loss of corporate deductions, and imposition of excise tax for the contribution of nondeductible amounts. c. Dilution of voting rights can be important in the case of a possible merger, buy-out, or similar transaction. This dilution can reduce the attractiveness for a purchase of the corporation by an outside buyer. d. Liquidity of the corporation can be an important factor because the stock will most likely have to be repurchased when distributions are made in the form of corporate stock. Under 4975(e)(7) and 409(h), the participant must be given the right to require the employer to repurchase the shares of stock at FMV. 3. 18
Employee Compensation and Retirement Plans
True or False 1. Taxpayer A, a dentist, fills a cavity for Taxpayer B, an attorney, in exchange for legal services. If the value of the dental services equals the value of the legal services, neither A nor B has earned taxable income. 2. As a general rule, any economic benefit granted an employee by his or her employer and intended to compensate the employee for services rendered represents gross income to the employee. 3. If the value of a noncash fringe benefit is not specifically excluded from gross income by statutory law, it must be included in the recipient's gross income. 4. The value of an annual employer-sponsored Christmas party may be excluded from an employee's gross income because it is a de minimis fringe benefit. 5. During the current year, AC Corporation required a key employee, Taxpayer X, to transfer from AC's San Diego, California office to AC's Phoenix, Arizona office. AC agreed to pay the commission charged by the real estate agent on the sale of X's home in San Diego. Because the payment represents a "working condition fringe benefit," the amount of the real estate commission paid is not included in X's gross income for the current year. 6. In 2010, M corporation transferred 1000 shares of its common stock worth $90,000 to Y, an employee, in connection with her performance of services for the corporation. The shares, however, are subject to substantial restriction: Y will have to forfeit the shares if she leaves M corporation before 2013. Y makes a 83(b) election to include the $90,000 value of the shares in her 2010 income. In 2013 Y is still working for M corporation and her 1,000 shares are worth $230,000. Y realizes $140,000 of taxable income on her 2013 return. 7. If a taxpayer makes a 83(b) election to recognize current income on the receipt of restricted property, the subsequent forfeiture of the property will give rise to a tax deduction. 8. Stock options are always taxed as income to the recipient on the day they are granted. 18-3 18-4 Chapter 18 Employee Compensation and Retirement Plans 9. The employee who exercises an ISO creates a deduction for his employer at that time equal to the difference between the option price and the market price. 10. B Inc. has an unfunded deferred compensation program for its employees. In the current year, B employees earned $120,000 in deferred compensation, none of which is taxable to any employee. If B Inc. is an accrual basis taxpayer, the corporation may claim a $120,000 tax deduction in the current year because of its deferred compensation liability. An accrual basis employer may take a deduction for deferred compensation when the employer promises to pay the deferred compensation, but does not set aside funds for that purpose. Employee Q has been a participant in his employer's non-qualified retirement plan for 25 years, during which period Q's employer has made regular annual contributions to the plan on Q's behalf. Q's right to his retirement fund is fully vested. Upon retirement, any amounts withdrawn from this plan will be fully taxable to Q. A taxpayer who is 60 years old on retirement in the current year may use the special forward averaging method of computing his or her income tax on a lump sum distribution from a qualified plan only once. Individuals who are not disabled and who make lump-sum withdrawals from an Individual Retirement Account (IRA) prior to age 591=2 years must pay a 10 percent penalty tax. An employer with a qualified defined contribution (profit sharing) plan is required to make an annual contribution to the plan. Only corporate employers may have qualified retirement plans for their employees. The employee retirement plan adopted by BT Corporation provides that the total amount of retirement benefits provided to a particular employee under the plan can be reduced by the amount of any social security benefits to which that employee is entitled. Because this provision of the plan discriminates in favor of the highly compensated employees of BT, the retirement plan cannot be "qualified" for Federal tax purposes. In order for a retirement plan to be "qualified," retirement benefits must vest immediately in participating employees. Qualified retirement plans may be funded or non-funded by the employer. A self-employed taxpayer is limited only by the amount of his or her earned income in determining the maximum annual contribution to a defined contribution Keogh plan. A self-employed individual who establishes a qualified retirement plan for his employees may be eligible for participation in the plan. In recent years Congress has passed legislation to systematically reduce the retirement benefits available to self-employed individuals through use of a Keogh plan. Lump sum distributions out of an Individual Retirement Account (IRA) are not eligible for the forward averaging tax computation. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. Test Bank 18-5 Multiple Choice 24. K Airlines provides its employees free air travel if space on the flight is available at departure time. Under 132, this fringe benefit a. b. c. d. Represents income to the employee in the amount of the seat's lowest rate Does not represent gross income to the employee Is a no-additional-cost service Both b. and c. 25. Which of the following fringe benefits may be taxable to the recipient? a. b. c. d. Employer-provided parking Employer-provided on-premises health club or athletic facility privileges Employer-provided interior decorating for a new personal residence Employer-provided child and dependent care services 26. Which of the following represents an excludable working condition fringe benefit under 132? a. b. c. d. e. Business magazine subscriptions paid for by an employer in the names of various employees Parking provided near its business by an employer for its employees On-premises athletic facilities provided by an employer to its employees All of the above Both a. and b. 27. A restaurant chain offers the following benefits to its employees. Which represents an excludable de minimis fringe benefit under 132? a. b. c. d. e. Annual employee picnic Employer-provided coffee and doughnuts Meal discount at any restaurant in the chain Both a. and b. All of the above 28. Under 83, property received for services is restricted property if it is a. b. c. d. e. Subject to substantial risk of forfeiture Immediately transferable by the recipient but held outside the United States Not immediately transferable by its recipient Both a. and c. Both a. and b. 29. In 2011, employee E receives 10 shares of the common stock of his employer, Beta Corporation, as compensation. However, E will have to return the shares if he leaves his position with Beta before 2012. If E does not make a 83(b) election with regard to the shares a. b. c. d. He will recognize no income in 2011 because of the receipt of the stock. He will never recognize income on the stock. He will recognize 2011 income equal to the current value of the shares. He will recognize income only when he leaves his position with Beta and forfeits his shares. 18-6 Chapter 18 Employee Compensation and Retirement Plans 30. In 2011, Corporation M transferred 1,000 shares of its common stock to employee Y as a year-end bonus. However, Y will forfeit the shares if he leaves his position with the corporation before 2013. Y makes a 83(b) election to include the $90,000 current value of the shares in his 2011 income. In 2013, Y is still working for Corporation M and his 1,000 shares are worth $230,000. Based on these facts a. b. c. d. Corporation M may take no deduction for the transfer of its own shares to Y. Corporation M may take a $90,000 deduction in 2011. Corporation M may take a $90,000 deduction in 2013. Corporation M may take a $230,000 deduction in 2013. 31. In 2011, P receives stock worth $15,000 from Q Corporation as payment for services rendered. The stock is subject to substantial risk of forfeiture, i.e., if P leaves Q Corporation before 2013, she must forfeit the stock. P chooses to make a 83(b) election and include the $15,000 value of the stock in her 2011 gross income. In 2013 the risk of forfeiture lapses, the property is worth $38,000. a. b. c. d. P must include $23,000 gross income attributable to the property in 2013. P has no gross income attributable to the property in 2013. P cannot recognize the gross income from the property in 2011. None of the above is correct. 32. During the current year, Corporation J granted a non-qualified stock option to Employee E. The option allowed E to buy 1,000 shares of J stock for $100 per share at any time during the next four years. At the date of the grant, the market price of E stock was $110 per share, and thus, the option's value was $10,000. Two years after the option was granted, E exercised the option when the market price of E stock was $160 per share. Based on these facts, E should report a. b. c. d. No income until he sells the 1,000 shares of E stock $10,000 of ordinary income in the current year, but no income in the year the option is exercised $10,000 of ordinary income in the current year, and $50,000 of ordinary income in the year the option is exercised No income in the current year and $60,000 of ordinary income in the year the option is exercised 33. In 2009, Corporation D granted a non-qualified stock option to employee Z, which entitled Z to purchase 500 shares of D stock at $100 per share at any time until 2014. Upon date of the option grant, D stock was selling at $90 per share. In 2012, when the market price of D stock had increased to $145 per share, Z exercised his option. Based on these facts, Z must recognize a. b. c. d. $50,000 ordinary income in 2009 $50,000 ordinary income in 2012 $22,500 ordinary income in 2012 No ordinary income until the stock is sold by Z 34. In 2009, Z received non-qualified stock options as part of her compensation from U Corporation. When granted, the options had no ascertainable value. In 2012, Z exercised the options and purchased 1,000 shares of U stock, market value $100 per share, for the option price of $70 per share. Accordingly, a. b. c. d. In 2012, Z must recognize $100,000 in ordinary income. In 2012, Z must recognize $70,000 in ordinary income. In 2012, Z must recognize $30,000 in ordinary income. None of the above is correct. Test Bank 18-7 35. In the current year, employee F is given an incentive stock option (ISO) entitling him to purchase 100 shares of his employer Sigma Corporation's stock for $50 per share. He exercises the option in the following year when the shares are selling for $80 per share. If F sells these 100 shares four years later for $200 per share, he will recognize a. b. c. d. A long-term capital gain of $120 per share A long-term capital gain of $150 per share Ordinary income of $30 per share and a long-term capital gain of $120 per share No income upon sale 36. For 421(a) to apply so that the exercise of an ISO will not result in income recognition to the owner, the stock purchased must not be disposed of a. b. c. d. Within two years from the date of granting Within one year from the date of exercise Within one year from the date of granting Both a. and b. 37. During the current year, Corporation P granted an incentive stock option (ISO) to Employee A. The option entitled A to purchase 500 shares of P stock for $150 per share. On the date the option was granted, P stock had a market value of $130 per share. Three years after the grant, A exercised the option when P stock had a market value of $190 per share. Eight months after A acquired the 500 shares, he sold them for $200 per share. Based on these facts, A should report a gain on sale of a. b. c. d. $20,000 ordinary income and $5,000 capital gain $25,000 capital gain $25,000 ordinary income $5,000 capital gain 38. Section 422A(b) sets forth a number of statutory requirements for an employee stock option to qualify as an incentive stock option (ISO). Primary requirements are that a. b. c. d. e. The option must be granted within 10 years of the date of adoption or the date of shareholder approval, whichever is earlier. The option price must be less than the market value of the stock at date of grant. The option must be exercised within 10 years of date of grant. Both a. and c. be done. All of the above are true. 39. In 2009, J Corporation granted employee B an ISO to purchase 2,000 shares of J stock with a current aggregate value of $100,000. In 2012, J Corporation granted B a second ISO to purchase 500 shares of J stock with a current aggregate value of $150,000. If B decides to exercise any of his ISOs in 2012, he may a. b. c. d. e. Purchase 1,000 shares through exercise of his 2009 option Purchase 333 shares through exercise of his 2012 option Purchase 500 shares through exercise of his 2012 option Do both a. and b. Do none of the above 40. Which of the following is true regarding incentive stock options (ISOs)? a. b. c. d. The value of stock with respect to which ISOs are exercisable shall not exceed $100,000 per calendar year per employee, the value of the stock being determined at the date of exercise. ISOs may be exercised only in the order in which received. The value of stock with respect to which ISOs are exercisable shall not exceed $100,000 per calendar year per employee, the value of the stock being determined at the date of grant. Both a. and b. 18-8 Chapter 18 Employee Compensation and Retirement Plans 41. If contributions are made to an employer-sponsored (i.e., not a Federal retirement program), qualified retirement plan, a. b. c. d. The employer's contributions on behalf of the employee are not includible in the employee's gross income. The employer is entitled to a current deduction for contributions to such plans. The employee includes the retirement benefits in his or her gross income in the tax year of receipt. All of the above are true. 42. If an employer's contributions are made to a non-qualified retirement plan in which employees are fully vested, a. b. c. d. The employer's contributions on behalf of the employee are includible in the employee's gross income. The employer is not entitled to a current deduction for contributions to such plans. The employee is allowed a deduction for current contributions, but must include retirement benefits in his or her gross income in the tax year of receipt. All of the above are true. 43. In the current year, ZT Inc., an accrual basis taxpayer, declares a $75,000 year-end bonus to its president, Mr. Z. Upon Z's request, ZT agrees to defer payment of the bonus for 10 years, at which time Z is anticipating retirement. The deferred compensation arrangement is unfunded, so that Z becomes an unsecured creditor of T. Based on these facts, which of the following is accurate? a. b. c. d. Although Mr. Z does not receive a cash payment of the bonus, he is in "constructive receipt," and therefore, must include the $75,000 in current year income. Although T does not pay the bonus, the liability incurred entitles ZT Inc. to deduct the bonus in the current year. Because the deferred compensation arrangement is not a qualified retirement plan, Mr. Z must include $75,000 in current-year income. Mr. Z has no tax liability on the $75,000 until the deferred compensation is actually paid. 44. During the current year, Taxpayer Q quits her job. As a participant in her employer's qualified retirement plan, Q is entitled to a payment of $100,000. Q never made any contributions of her own to this plan. Based on these facts, which of the following statements is incorrect? a. b. c. d. If Q decides to take her $100,000 in the form of a yearly annuity for life, the full amount of the annual payment received must be included in her gross income. If Q is age 61 in the current year and decides to take her $100,000 in the form of a lump sum distribution, she may elect to pay the tax on the distribution over a five-year period. If Q decides to take her $100,000 in the form of a lump sum distribution, she may roll the amount over into an IRA and avoid paying any current tax on the distribution. If Q is age 40 in the current year, she will pay a 10 percent penalty tax on any amount of the distribution included in her gross income for the year. 45. Which plans are included under defined contribution plans? a. b. c. d. e. 401(k) salary-reduction plans Profit-sharing plans Employee Stock Ownership Plans Money purchase pension plans All of the above 46. Under 401, contributions made as part of a qualified retirement plan must be paid into a trust a. b. c. d. Administered by the employer Established by the employees That may be used by the corporation as a source of emergency funds None of the above is correct. Test Bank 18-9 47. Under 401, which of the following is true regarding a qualified retirement plan? a. b. c. d. Any employee who has reached 18 years of age must be eligible to participate after completing one year of service for the employer. The plan may not exclude an employee from participation because of a maximum age. The plan may exclude an employee who is a union member. The plan will provide sufficient coverage if it benefits at least two-thirds of all employees not considered highly compensated. 48. Under a defined benefit plan for 2011, a. b. c. d. The highest annual retirement benefit payable may not exceed $195,000. The highest annual retirement benefit payable may not exceed 100 percent of the employee's average earnings in his or her three highest compensation years. No minimum current contribution is required. None of the above is correct. 49. Which of the following is not a benefit of a qualified employer retirement plan? a. b. c. d. Earnings on amounts contributed to the plan are tax-exempt. There is no limitation on the annual amount an employer may contribute to the plan for the benefit of each employee. Benefits paid from a plan in a lump sum distribution may be taxed using a beneficial five-year forward averaging method. Participant employees are not taxed on employer contributions until such contributions are withdrawn from the plan. 50. Mr. M has earned income of $125,000 in the current year and is a participant in his employer's qualified retirement plan. Mrs. M is a housewife and has no earned income. During 2011, the Ms may make total deductible contributions to their IRAs of a. b. c. d. $0 $4,000 $5,000 $10,000 51. Mr. T, an architect, had current year earned income of $25,000 in 2011. Mrs. T earned $1,800 during the year by typing for university students. The maximum amount the Ts may collectively contribute to their Individual Retirement Accounts is a. b. c. d. e. $4,000 $5,000 $5,800 $8,000 $10,000 18-10 Chapter 18 Employee Compensation and Retirement Plans 52. Which of the following rules apply to an Individual Retirement Account? a. b. c. d. The entire annual contribution to the IRA may be deductible for a single taxpayer who is not an active participant in a qualified retirement plan. The entire annual contribution to the IRA may be deductible for a single taxpayer who is an active participant in a qualified retirement plan. The entire annual contribution to the IRA may be deductible for a taxpayer who is an active participant in a qualified retirement plan but has A.G.I. over the applicable dollar amount (i.e., $89,000 for MFJ in 2011, and $55,000 for single taxpayers in 2011). Either a or b. 53. Which of the following is accurate concerning annual contributions by an employer to a Simplified Employee Pension? a. b. c. d. They are made directly into a qualified trust. They are excludable from an employee's gross income. They are limited to the lesser of $30,000 or 15 percent of employee compensation. Both b. and c. 18
Employee Compensation and Retirement Plans
Solutions to Test Bank
True or False 1. False. Both taxpayers have taxable income equal to the value of the services received. [See pp. 18-2 and 18-3, and Reg. 1.61-2(d).] 2. True. Compensation may take the form of a variety of noncash economic benefits. (See pp. 18-2 and 18-3.) 3. True. The value of a noncash fringe benefit is includible in gross income unless a specific statutory exclusion (e.g., 132) applies. [See pp. 18-2 and 18-3 and 61(a)(1).] 4. True. The value of a company party is clearly negligible. (See pp. 18-2 and 18-3.) 5. False. The payment of the commission is not a "working condition fringe benefit" because X could not have deducted the payment under 162 if he had paid the commission directly. Therefore, the payment is not excludable from income under 132(d) or any other section and is includible in X's gross income for the year. (See p. 18-3 and 132.) 6. False. By making the 83(b) election in 2010, Y accelerated recognition of gross income on the restricted stock. Y reasoned that the market value of the stock would increase and that the marginal tax rate in 2010 would not be significantly lower than in 2012. Because she took the gamble of accelerated recognition, Y does not have additional gross income in 2012 when the risk of forfeiture is over. (See pp. 18-3 and 18-4.) 7. False. The lack of such a deduction is a "risk" associated with the 83(b) election. (See footnote 5 and pp. 18-5 and 18-6.) 8. False. Stock options generally have no value when issued because the option price is equal to or less than the market price of the stock. Therefore, there is no taxable income to the recipient. (See p. 18-34.) 9. False. The employer receives no deduction for this spread amount. (See pp. 18-35 and 18-36.) 10. False. The deduction to the employer is not available until the employees are taxed on the deferred compensation. (See p. 18-33 and Rev. Rul. 69-650.) False. No deduction may be taken until the employee is actually paid the deferred compensation. (See p. 18-34.) 11. 18-11 18-12 Chapter 18 Employee Compensation and Retirement Plans 12. False. Because Q was taxed on the contributions when made by the employer, subsequent withdrawals of such contributions are nontaxable. (See p. 18-34.) True. Thus, such a taxpayer who could possibly receive more than one such distribution must decide which one will be subject to the forward averaging method. A taxpayer who was age 50 before January 1, 1986 may use the forward averaging computation for lump sum distributions received prior to reaching age 591=2. (See p. 18-7 and 402(e)(4)(B).) True. The 10 percent penalty tax on "premature" withdrawals is authorized by 72(t). (See p. 18-8.) False. Annual contributions are not required as long as such contributions are recurring and substantial over the life of the plan. (See p. 18-7.) False. Any type of employer may have a qualified retirement plan for employees as long as the requirements of 401 through 415 are met. (See p. 18-13 and 401(a).) False. Integration of social security benefits into a qualified retirement plan is permitted by 401(a)(5). As long as the distribution of benefits is determined under a reasonable and equitable formula, there is no prima facie discrimination. (See p. 18-14.) False. In a qualified plan, the right to the benefits vest in the employers according to one of two statutory schedules; immediate vesting is not required. (See p. 18-15 and 411(a)(2).) False. A qualified plan must be funded. (See pp. 18-15 and 18-16 and 401(a)(1) and 412.) False. A self-employed taxpayer may contribute no more than the lesser of 100% of earned income or $49,000 in 2011. (See p. 18-17 and 415(c)(1) and (3)(B).) False. Such an individual is not eligible for participation. (See p. 18-18.) False. Congress has strived to increase Keogh benefits to create parity between such plans and qualified retirement plans. (See p. 18-18.) True. This is a major limitation of the utility of IRAs. (See p. 18-22 and 408(d)(1).) 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. Multiple Choice 24. d. The no-additional-cost service must be one that is offered to customers in the ordinary course of business in which the employee is performing services. (see pp. 18-2 and 18-3 and 132.) There is no specific statutory exclusion for this fringe benefit. Employer-provided parking and health club privileges are excluded from gross income per 132(h)(4) and (5). Section 129 provides an exclusion for employer-provided dependent care. (See pp. 18-2 and 18-3 and 132.) A "working condition" fringe benefit is any property or service that if taken into income by the employee would be deductible by him or her under 162 or 167. (See pp. 18-2 and 18-3 and 132.) The value of a de minimis fringe benefit must be so small as to make accounting for it unreasonable or administratively impractical. (See pp. 18-2 and 18-3 and 132.) The location of the property is irrelevant under 83. (See p. 18-3.) will recognize income when the risk of forfeiture of the shares lapses in 2011. (See Example 1, p. 18-5, and 83(a).) M's deduction corresponds to Y's income inclusion. (See Example 3, p. 18-5, and 83(h).) 25. c. 26. d. 27. d. 28. 29. d. a. 30. b. Solutions to Test Bank 18-13 31. b. The disadvantages to the 83(b) election are that (1) if the stock is forfeited, P would not receive a deduction for the $15,000 she included in her 2011 gross income; or (2) if the stock is worth less than $15,000 in 2013, P suffered a larger gross income inclusion than she need have, as well as acceleration of income recognition. (See Example 3, and p. 18-5.) Because the option had an ascertainable value of $10 per share for 1,000 shares at the date of the grant, E must recognize compensation income of that amount in the year the option is granted. Upon subsequent exercise, no further compensation income is recognized. (See Example 30, p. 18-36, and Reg. 1.83-7(a).) The taxable "bargain element" generated by the option exercise in 2012 is 500 shares ($145 market price $100 option price) $22,500. (See Example 30, p. 18-35, and Reg. 1.83-7(a)) Z must recognize the "bargain element" of the stock purchased as ordinary income. ($30 per share bargain element 1,000 shares $30,000 in ordinary income). (See Example 30 and p. 18-35.) F's gain is the difference between the $200-per-share selling price and his cost basis of $50 per share. (See Example 30, p. 18-35, and Reg. 1.421-5(a)(4).) An individual may not dispose of stock purchased upon exercise of an ISO within two years from the date of granting or within one year from the date of exercise. (See p. 18-36 and 421(a).) Because A sold the stock within one year from date of his exercise of the ISO, he must recognize the "bargain element" of $20,000 (($190 500 shares $95,000) ($150 500 shares $75,000)) as ordinary income. The remainder of the gain, $5,000 ($200 500 shares $10,000 $95,000), is capital gain. (See p. 18-36, and 421(b).) ISOs may never be granted with a value that is less than the market value of stock at date of grant. A stock option that has a price lower than the market value on date of grant would cause the recipient to recognize the difference as income. (See p. 18-36.) B is limited to the exercise of up to $100,000 in value of his available options. The value of the stock is determined at the date of the ISO. Thus, he may purchase up to 2,000 shares of his 2008 ISO (2,000 shares valued at $100,000) or 333 shares of his 2011 ISO (333 shares valued at $99,900). (See p. 18-36.) The value of stock is determined at the date of the ISO grant. There is no requirement to exercise the ISOs in the order received. (See p. 18-37.) Such private retirement plans may supplement or entirely replace a federally subsidized retirement program (e.g., Social Security and the Federal Railroad Retirement System). (See p. 18-7.) The employer generally is allowed a deduction for contributions on behalf of an employee. The employee is not allowed a deduction for current contributions to non-qualified plans. These payments are viewed as an investment made by the employee that will be recouped when the retirement benefits are paid. (See p. 18-7.) In an unfunded deferred compensation arrangement, the employee recognizes no income and the employer claims no deduction until the compensation is actually paid. (See p. 18-33; Rev. Rul. 69-649, 1969-2 C.B. 106; and Rev. Rul. 69-650, 1969-2 C.B. 106.) The tax on a lump sum distribution may be computed using a five-year forward averaging method. However, the entire amount of tax is payable in the year the distribution is received. (See p. 18-7 and 402(e).) All four plans involve a defined annual employer contribution. (See p. 18-13.) 32. b. 33. c. 34. c. 35. b. 36. d. 37. a. 38. d. 39. d. 40. c. 41. d. 42. a. 43. d. 44. b. 45. e. 18-14 Chapter 18 Employee Compensation and Retirement Plans 46. d. The trust must be domestic (U.S.) and must be for the exclusive benefit of the employees. The plan must be in writing and its provisions communicated to all employees. The trustee must owe sole allegiance to the employees/beneficiaries. (See pp. 18-13 and 18-14.) Any employee who has reached the age of 21 and completed one year of service must be eligible to participate. The plan must benefit at least 70 percent of all employees not considered highly compensated. (See p. 18-14.) The highest annual retirement benefit payable may not exceed the lesser of $195,000 or 100 percent of the employee's average earnings. Thus, the ceiling on the annual benefit is $195,000. A minimum current contribution is required by statute. (See p. 18-17 and 412.) Section 415 provides annual limits on the contributions that can be made to both defined contribution and defined benefit plans. (See p. 18-17.) The Ms can make a contribution to an IRA for Mr. M and a spousal IRA for Mrs. M. The combined contribution is limited to $10,000 for 2011. However, because Mr. M is a participant in a qualified plan and the A.G.I. on the joint return exceeds $66,000, no amount of the contribution is deductible. (See p. 18-22 and 219(c) and (g).) $5,000 for Mr. T and $1,800 (100% of compensation) for Mrs. T, since the maximum contribution is the lesser of (1) $5,000 (in 2011), or (2) 100 percent of compensation. (See p. 18-23 and 219(b).) Annual contributions to IRAs made by taxpayers who are active participants in qualified retirement plans may be deductible in full as long as their A.G.I. is below the applicable dollar amounts of $89,000 for MFJ and $55,000 for a single taxpayer in 2011. If their A.G.I. exceeds this applicable amount, their deduction for IRAs is phased-out under 219(g). (See p. 18-24.) SEPs are designed to avoid many of the complexities of a qualified retirement plan. No qualified trust is required; contributions go directly into the employee's existing IRA, and are excludable from the employee's gross income. The annual limit is the lesser of 25 percent of employee compensation or $49,000. (See p. 18-31 and 408(k) and 402(h).) 47. b. 48. a. 49. b. 50. c. 51. c. 52. d. 53. d. ...
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- Spring '11
- ESOP, a. b. c.