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Unformatted text preview: tment income of more than $1,000 for the year. If the borrower has more than $1,000 of net
investment income for the year, interest is imputed, but it will not be greater than the
amount of the borrower’s net investment income for the year. If the loan is more than
$100,000, the imputed interest is equal to the interest calculated using the AFR less interest
calculated using the stated rate of the loan.
19. Compare and contrast compensatory damages and punitive damages.
Compensatory damages may be intended to compensate for damage to property, for recovery of expenses incurred, for income lost, or for personal injury. Punitive damages, on the
other hand, are intended to punish the offending party. Punitive damages must be included
in the recipient’s gross income. Compensatory damages may be excluded from gross income
under certain circumstances (i.e., damages for physical personal injury). The tax treatment
for the receipt of such payments is the same whether the payments are received as a result of
court action or not. The treatment is also the same whether the payment is received from
the injuring party or from an insurance company. DISCUSSION QUESTIONS 23 20. Discuss the tax treatment of child support payments.
Child support payments are excluded from the gross income of the payee and are not
deductible by the payor since these payments simply satisfy the legal obligation of the payor
to support the children.
21. When is the amount of debt forgiven not included in gross income?
The amount of debt forgiven need not be included in gross income in certain circumstances, including the following:
• Certain forgiven student loans,
• Debts forgiven in Title 11 bankruptcy,
• Debts forgiven when a taxpayer is insolvent (up to the amount of a taxpayer’s insolvency),
• Debt cancelled as a result of Hurricane Katrina,
• Forgiveness of qualified farm indebtedness,
• Forgiveness of qualified real property business indebtedness,
• Forgiveness by a seller of a buyer’s debt, and
• Forgiveness of debt as a gift.
22. Explain the claim of right doctrine.
When an accrual method taxpayer earns income, that income is normally included in gross
income. There are circumstances, however, under which the situation is not so clear cut. For
situations in which the customer pays and then requests or sues for a full or partial refund,
courts have established the claim of right doctrine. Under this doctrine, the taxpayer must
report the entire payment in gross income in the year of payment even though part or all of
the payment may have to be repaid to the customer. If the customer is repaid in a later year,
the taxpayer is allowed a tax deduction in the year of repayment. 24 CHAPTER 4: G ROSS INCOME FROM PERSONAL AND INVESTMENT ACTIVITIES MULTIPLE CHOICE PROBLEMS
1. Gibbs has an account at First Maryland Bank. $10,000 of his account balance is invested in
a certificate of deposit (CD). When must interest paid on the CD be included in Jonas’
a. Interest on a CD is never included in income.
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- Spring '12