Chapter 4 Solutions
26. Allison dies during the current year. She is covered by a $1,000,000 life
insurance policy payable to her husband Bob. Bob elects to receive the
policy proceeds in 10 annual installments of $120,000. Write a letter to Bob
explaining the tax consequences of the receipt of each installment.
Life insurance proceeds are excluded from tax. Therefore, the
$1,000,000 face value of the policy is excluded as it is received.
However, the earnings on the policy during the time it is held by the
insurance company are not excludable. The total interest earned is
$200,000 [($120,000 x 10) - $1,000,000]. As each payment on the
policy is received, Bob will exclude $100,000 ($1,000,000 ÷ 10) and
include $20,000 ($200,000
10) in gross income.
27. Earl is a student at Aggie Tech. He receives a $5,000 general scholarship
for his outstanding grades in previous years. Earl is also a residence hall
assistant, for which he receives a $1,000 tuition reduction and free room
and board worth $6,000 per year. Earl's annual costs for tuition, books, and
supplies are $8,000. Does Earl have any taxable income from the
scholarship or the free room and board?
Earl has $7,000 ($6,000 + $1,000) of income from the receipt of the
free room and board. Even if the room and board were considered to
be a scholarship, it could not be excluded because it is designated for
payment of costs that are not direct education costs. The $5,000
general scholarship is excluded because it is less than the actual
NOTE: Earl may be able to exclude the value of the room and board
and the $1,000 tuition reduction if it meets the requirements for meals
and lodging provided by an employer. To exclude the value of meals,
the meals must be provided on the employer's premises and be for the
convenience of the employer. The same requirements are applicable
to lodging with the extra provision that the lodging be required in
order to accept employment. In determining whether this exclusion
applies, one would first have to determine whether Earl is an
employee of the residence hall. Assuming that he is, it does not seem
that the meals would meet the convenience of employer test (there is
no advantage to the employer in having Earl eat in the residence hall
cafeteria) and would not be excludable. The lodging would meet the
convenience test and would be excludable.