Homework answers / question archive /                                                                                                                                                                                 5-1          CHAPTER 5 – GROSS INCOME AND EXCLUSION TAXABLE INCOME   COMPENSATION FOR SERVICE VERSUS GIFT (line 7 of Form 1040)        Compensation for service and forgiveness of debt are taxable, while gift is nontaxable on the donee

                                                                                                                                                                                5-1          CHAPTER 5 – GROSS INCOME AND EXCLUSION TAXABLE INCOME   COMPENSATION FOR SERVICE VERSUS GIFT (line 7 of Form 1040)        Compensation for service and forgiveness of debt are taxable, while gift is nontaxable on the donee

Taxation

Share With

---

                                                                                                                                                                                5-1         

TAXABLE INCOME

 

COMPENSATION FOR SERVICE VERSUS GIFT (line 7 of Form 1040)

       Compensation for service and forgiveness of debt are taxable, while gift is nontaxable on the donee.  Alimony

is tax deductible on the payor and taxable on the payee, while child support payment is nondeductible and nontaxable. Compensation includes salaries, wages, tips, commissions, bonus, jury duty fees, strike benefits paid out of union dues,                                                   

                                                                             

EXAMPLE 1 –  IS THIS A TAXABLE INCOME?     

  2. Brian borrowed $1,000 from his neighbor.  Later his neighbor forgives Brian’s debt, but Brian must paint his neighbor’s house in return.  Is this a taxable income on Brian and a deductible expense on his neighbor?

  3. The Daughter borrowed $1,000 from the Mother to buy a computer for college education.  On the Daughter’s wedding day the Mother forgave the Daughter’s debt.  Is there any taxable income on the Daughter?  

  4. Ed and Susan are divorced with a child, 10, living with Susan.  It was agreed that Ed will pay Susan $5,000 of support a year.  However, when the child reaches the age of 19, the support will reduce to $3,000 a year.  What is the deductible alimony on Ed and taxable alimony on Susan, respectively? 

 

EXAMPLE 2 – DIVIDEND AND INTEREST – DIVIDEND AND INTEREST

       Is dividend a taxable income?

	Answer
Cash dividend
Stock dividend
Stock dividend with cash option

                                                                                                                                                              

		Answer
1	On 12-31-Year 1 Peter received $50 cash dividend from IBM common stock.  Is this a taxable income on Peter in Year 1?
2	On 12-31-Year 1 Richard received 10 shares of stock dividend from IBM common stock.  The current market price of IBM common stock is $5 per share.  Is this stock dividend a taxable on Richard in Year 1?
3	On 12-31-Year 1 IBM Company gave Stanley a choice of either $50 cash dividend or 10 shares of IBM common stock with a current market value of also $50.  Stanley chose 10 shares of stock dividend.  Is this stock dividend taxable on Stanley in Year 1?
4	On 12-1-Year 1 IBM Company declared $5 per share cash dividend on the record of 12-10-Year 1.  On 12-5-Year 1 Vincent sold 10 shares for cash.  Is the dividend a taxable income on Vincent in Year 1?
5	On 1-1-Year 1 Ed purchased the New Jersey State bonds for a cost of $1,000.  On 12-31-Year 1 he received $100 interest and sold the entire bonds for $1,200 in cash.  What is the taxable income on Ed in Year 1?  (1,200 – 1,000 = 200 capital gain).

                                                                                                                                                                             5-2         

EXAMPLE 3 – CASH PROCEEDS FROM LIFE INSURANCE POLICY

                                                                                                                

      Is cash proceeds from life insurance policy a taxable income?

	Answer
Cash proceeds as a life insurance policy beneficiary.
Cash proceeds as a life insurance policy purchaser      (after deducting cost and premium paid).

                                                                                                                                                                                                   

		Answer
1	On 1-1-Year 1 Father purchased a $1,000 face value life insurance policy and named his son, Andy, as the beneficiary.  On 12-31-Year 1 Father died and the son received $1,000 cash from the life insurance company.  Is this $1,000 a taxable income on the son in Year 1?
2	On 1-1-Year 1 Father purchased a $1,000 face value life insurance policy and named his first son, Andy, as the beneficiary.  On 2-1-Year 1 the second son, Bob, purchased the policy from the first son, Andy, for a cost of $300.  After that time Bob paid $100 premium for the policy.  On 12-31-Year 1 Father died, and Bob received $1,000 cash from the insurance company.  How much is the taxable income on Bob in Year 1? (Net gain = 1,000 proceeds – 300 cost – 100 premium = 600).

 

IS STATE INCOME TAX REFUND TAXABLE?

       State income tax refund and medical expense reimbursement are nontaxable if standard deduction was used.  If itemized deductions were used, the state income tax refund is taxable only to the extent by which the total itemized deductions exceed standard deduction, i.e.,                       

   

State income tax refund > Taxable income < (Itemized deductions – Standard deduction)

 

	Answer
Standard deduction
Itemized deduction

 

 

 

 

 

EXAMPLE 4 – IS STATE INCOME TAX REFUND TAXABLE? (Line 10 of Form 1040)

       Ed is 30 years old and single using standard deduction in CASE 1 and itemized deductions in ASES 2 and 3.  In 2016, he has the following total itemized deductions ($5,000, $6,700, and $6,400 in 3 different cases).  In 2017 he receives $300 of New Jersey state income tax refund in all 3 CASES. 

 

       REQUIRED: Is this $300 state income tax refund taxable in 2017? (Enter the taxable amount on line 10 of Form 1040).  (Note the standard deduction in 2016 was $6,300) 

      

IS MEDICAL EXPENSE REIMBURSEMENT TAXABLE?

       Medical expense is deductible in one year.  If the taxpayer receives reimbursement in the same year, the deductible medical expense is reduced by the amount of reimbursement.  If the taxpayer receives the reimbursement in the following year, should the reimbursement be taxable in the year of receipt?  It depends on to what extent the medical expense was deducted in the preceding year. 

 

 

 

                                                                                                                                                                             5-3         

       It should be noted that only the medical expense in excess of 10% of the adjusted gross income is deductible.  Further, medical expense is a part of “itemized deduction.”  The “standard deduction” for a single in 2014 is already $6,200.  A taxpayer chooses “itemized deduction” only if the total itemized deduction is more than $6,200.  Thus, the benefit is itemized deduction is the total itemized deduction in excess of the $6,200 standard deduction.

 

       The reimbursement is taxable only to the extent of the deductible medical expense in excess of the $6,200 deduction.  In other words, if the reimbursement is less than the excess of the deductible medical expense over the $6,200 standard deduction, the entire amount of reimbursement is taxable.  If the reimbursement is more than the excess of the deductible medical expense over the $6,200 standard deduction, the reimbursement is taxable only up to the amount of deductible medical expense.  In short,

 

Medical expense reimbursement > Taxable income < (Itemized deductions – Standard deduction)

 

EXAMPLE 5 – IS MEDICAL EXPENSE REIMBURSEMENT TAXABLE?

       John is single using itemized deductions.  In 2016 he has $100,000 of adjusted gross income.  In 2016 the only itemized deduction he has is $17,400 of medical expense he paid to a hospital for his surgery.  In the following year of 2017 John receives $1,200 of medical expense reimbursement from his insurance company.    

       REQUIRED: How much of his $1,200 reimbursement is taxable in 2017?

      

ALIMONY RECEIVED (Lines 11 of Form 1040)

                                                                                                                             

EXAMPLE 6 – ALIMONY RECEIVED

       John and Betty are divorced.  John agrees to give Betty $10,000 cash every year for living expense.  John further agrees to give Betty $8,000 every year to support their 3-year old child who lives with Betty.  John also agrees to give Betty their vacation home as Betty’s principal residence, which is worth $200,000. 

 

       REQUIRED: What is Betty’s taxable income?  What is John’s “for AGI’ (adjusted gross income) deduction? 

PENSION AND ANNUITY (Line 16 of Form 1040) 

 

A = Employee-contributed portion of the cost of pension fund.

B = Pension received per year.

C = Life expectancy (multiplier) from the following table from the IRS: 

 

                                                                                                                                                                             5-4         

Age of retirement	Life expectancy (Multiplier)
55	28.6
56	27.7
57	26.8
58	25.9
59	25.0
60	24.2
61	23.3
62	22.5
63	21.6
64	20.8
65	20.0
66	19.2
67	18.4
68	17.6
69	16.8
70	16.0
71	15.3
72	14.6

D = B x C = Total expected return of pension for life.

E = A / D = Exclusion ratio = cost/pension ratio.

F = B x E = Exclusion amount = nontaxable portion of pension per year.

G = B - F = Taxable portion of pension per year.

PENSION =	TAXABL or NONTAXABLE?
Principal = From employer …………………………………………………                   + From employee = Before tax (deferred compensation)…                                                   + After tax ………………………………	TAXABLE TAXABLE NONTAXABLE
+ Interest	TAXABLE

 

EXAMPLE 7 – ANNUITY

       On January 1, Year 1 Harvey retired at the age of 55 and purchased an annuity of $50,000 from Chase Life Insurance Company.   The annuity will pay Harvey $400 every month for life starting from January 31, Year 1. 

       REQUIRED: What is Harvey's taxable pension income in Year 1? 

      

EXAMPLE 8 - PENSION

       On January 1, Year 1 Allen retired at the age of 65.  Throughout his employment, he has contributed

$40,000 to the pension fund from his own savings (not deferred compensation), and his employer has

contributed $60,000.  Allen is expected to receive $700 a month of pension benefits from the pension fund for

life starting from January 1, Year 1.

       REQURED:  What is Allen's taxable pension income in Year 1?

       

                                                                                                                                                                      5-5         

EXAMPLE 9 – PENSION

       On January 1, Year 1 Bruce retired at the age of 50.  Throughout his employment so far, he has contributed

$40,000 to the pension fund from his own savings (not deferred compensation), and his employer has contributed $60,000.  On January 1, Year 1 he withdrew $3,000 from his pension account for no medical or any other reasons. 

What is Bruce's taxable pension income in Year 1? 

       REQURED: Is there any penalty in income tax? 

 

IMPUTED INTEREST

       Interest-free loan between employer and employee, between company and stockholder, and between

two individuals are subject to imputed interest equal to the Federal borrowing rate to be compounded semi-annually.  The lender must recognize taxable interest income, and the borrower can deduct equal amount of interest.  There is a exemption amount available:

       -   $10,000 exemption for the gift giver, between the employer and the employee, and between the company and 

                         the stockholder, and a

       - $100,000 exemption between two individuals (not a gift giver). 

                                                                                                                      

EXAMPLE 10 – IMPUTED INTEREST

       On 1-1-Year 1 Bill borrowed $11,000 from his employer, Harrison Company at free of interest charge for a period of two years. 

       REQUIRED: How much is the imputed interest to be recognized both parties in Year 1?

     

SOCIAL SECURITY BENEFITS (Line 20, Form 1040)

       Only a portion of the social security benefits (Form SSA-1099) is taxable.  They do not include medicare benefits.         

 

Adjusted gross income (excluding social security benefits). + Tax-exempt interest, such as interest from municipal bonds. + Excluded foreign income + 50% of social security benefits                                           . Provisional income = A

.                                                                                                                                                      .

	If provisional income A =	Taxable social security benefits =
Single	A =< $25,000	$0.
	$25,000 < A =< $34,000	Lesser of     a. 50% x social security benefits, or                      b. 50% x (A - $25,000)
	A > $34,000	Lesser of     a. 85% x social security benefits, or                      b. 85% x (A - $34,000)                                + Lesser of    c. $4,500, or                                                                                                                   d. 50 % x Social security benefits
Married joint	A =< $32,000	$0.
	$32,000 < A =< $44,000	Lesser of     a. 50% x social security benefits, or                      b. 50% x (A - $32,000).
	A > $44,000	Lesser of     a. 85% x social security benefits, or                      b. 85% x (A - $44,000)                                   + Lesser of    c. $6,000, or                                                                    d. 50 % x Social security benefits
Married separate		Lesser of     a. 85% x social security benefits, or                      b. 85% x A.

                                                                                                                                                                             5-6                                                                                                                     

EXAMPLE 11  – TAXABLE SOCIAL SECURITY BENEFITS

       John is single and 65 years old.  In the current year he has:

1. Wages .............................................. ……………….$24,000

2. Interest income from New Jersey State bonds .........   2,000

3. Social security benefits received (Form SSA-1099) ..  8,000

 

       REQUIRED: What are John’s taxable social security benefits in the current year?

                                                                 

EXAMPLE 12 – TAXABLE SOCIAL SECURITY BENEFITS

       Bill is single and 65 years old.  In the current year he has the following income:

1. Wages ....................................………………………$26,000

2. Interest from bank account ..............…………………..3,000

3. Interest from New York City bonds ........…………….. 2,000

4. Social security benefits received (Form SSA-1099) …8,000

 

       REQUIRED: What are Bill’s taxable social security benefits in the current year? 

                                                        

EXAMPLE 13 – TAXABLE SOCIAL SECURITY BENEFITS

       Andy and Sue, both 65, are married filing a joint return.  In the current year they have the following income:

1. Andy's wages ....................................... ………….,$28,000

2. Interest income from New Jersey State bonds ........ 2,000

3. Social security benefits received (Form SSA-1099) .8,000

 

     REQUIRED: What are their taxable social security benefits in the current year? 

                                                                                                                                                                             5-7                                                                                                                     

EXAMPLE 14 – TAXABLE SOCIAL SECUITY BENEFITS

       Carl and Joan are married filing joint return and both are 65 years old.  In this year they have the following income:

 

1. Carl's wages .....................................……………….$41,000

2. Carl's unemployment compensation benefits ………...1,000

3. Interest income from Essex County bonds ,..…………2,000

4. Social security benefits received (Form SSA-1099) …8,000

 

       REQUIRED: What are their taxable social security benefits in the current year? 

 

EXAMPLE 15 – IS THIS SCHOLARSHIP A TAXABLE INCOME?     

       1. Gary is a college student on the Dean’s list.  He received $1,000 scholarship for his high grades, in which he spent $100 for tuition, $200 for books, and $700 for room and board.  Is there any taxable income on Gary? 

 

       3. Jerry is a college student on the Dean’s list.  He received full tuition and fees waiver (remission) for his high grades.  He further received $1,000 of Chase Memorial Scholarship in cash.  Is there any taxable income on Jerry? 

 

EXAMPLE 16 – IS THIS LIFE INSURANCE PROCEEDS A TAXABLE INCOME?     

       1. David's father purchased $50,000 of life insurance policy and named David as the beneficiary.  In Year 1 the father died.  The insurance company gave David an option to receive $50,000 in Year 1 or an annuity of $12,000 every year for the next 5 year.  David chose the latter.  Is there any taxable income in Year 1 on David?

                                                                                                                                               

       2. Jerry's father purchased a $50,000 life insurance policy and named Jerry as the beneficiary.  In Year 1 Jerry sold that policy to his brother, Ed, for $8,000.  In Year 2 Ed paid $2,000 premium to the insurance company.  In

 Year 2 the father died and  Ed chose to receive the entire $50,000 face value.  Is there any taxable income on Ed in Year 2.

 

 

EXAMPLE 17 – IS THIS FOREIGN EARNED INCOME A TAXABLE INCOME?     

       Don is assigned by his company to work in Japan.  He earned $101,600 of salary, but he also incurred

$1,000 of unreimbursed travel expense.  How much is the taxable income and deductible travel expense?

                                                                                                                                                                                                                                                                                                                                          

EXAMPLE 18 – IS THIS DISCHARGE OF DEBT A TAXABLE INCOME?     

       1. Harvey borrowed $1,000 from his father to buy a computer for his college education.  Upon graduation his father cancelled the debt.  Is this a gift or a discharge of indebtedness?  Is there any taxable income on the part of Harvey?

 

       2. Allen purchased a refrigerator from Sears Store for a price of $1,000 payable in 5 equal annual installment payments of $200 per year for 5 years.  Allen always paid the installment exactly on time each time for the last 4 years.  In order to appreciate his good credit.  Sears Store cancelled Allen's final installment payment of $200.  Is this $200 a gift or a discharge of indebtedness?  Is there any taxable income on the part of Allen?

 

                                                                                                                                                                                 5-9

 

       3. Assume the same fact in ITEM #2 above, except that the refrigerator has defect.  The $200 cancellation

of the last installment payment is due to this defect.  Is there any taxable income on the part of Allen?

                                                 

                                                                                                                                                   

EXAMPLE 19 – NONTAXABLE EMPLYEE FRINGE BENEFITS.  Is this taxable?      

       1.Jackson Company purchased a comprehensive medical insurance policy for all its employees

and their dependents.  Andy is one of the employees.  He received the following medical benefits

 

       a. His wife’s surgery in a hospital for a cost of $2,000.  The insurance company paid it.  Is this a taxable income on Andy? 

 

       b. Andy’s face-lifting cosmetic surgery in a hospital for a cost of $1,000.  The insurance company paid it.  Is this a taxable income on Andy? 

     

       5. Ed is 57 years old and the president of Harrison Company.  His company purchased a $60,000 face value of life insurance policy for him.  Is there any taxable income on the part of Ed? 

                                                                                                                                                                        

       7. Gary has a child and his company provides a day-care center for him when Gary is working.  The day-care center is worth $6,000 a year.  Is there any taxable income on the part of Gary?

                                                                                                                                                                                                                                                                                                                                       

       8. Harry paid $6,000 tuition for taking undergraduate courses at State University.  His employer paid him $6,000 tuition reimbursement.  Is there any taxable income on Harry?  

 

                                                                                                                                                                               5-11

       9. Jerry’s employer gives him an option to receive either $1,000 cash or $1,000 worth of day-care service

for his child.  He chooses $1,000 cash.  Is this a taxable income on Jerry? 

       10. Ken’s employer gives him an option to receive either $1,000 cash or $1,000 worth of day-care service for his child.  He chooses the $1,000 worth of day-care service.  Is this a taxable income on Ken? 

                                                                                       

                                                                                                                                             

       14. Peter is an employee of a law firm.  The law firm handles Peter’s divorce case for a price of $700.  The regular price to a customer is $1,000.  Is there any taxable income on Peter?

                                                                                                              

       15. Stern Department Store allows officers to purchase its merchandise at 40% discount, and ordinary

employees at 10% discount, while Stern’s gross margin is 40%.  John is the president and purchased a

fur coat by paying only $700, while the regular price to a customer is $1,000.  Tom is a clerk and purchased a TV set by paying $900, while the regular price to a customer is $1,000.  Is there any taxable income on John and Tom, respectively? 

       17. Stanley is a Vice-President of Garrison Company.  Stanley parked his car in the garage next to his office for  monthly fees of $260.  Garrison gives him $260 a month as a subsidy.  Is there any taxable income on Stanley?

       18. On the Christmas Party, every employee received $500 of year-end bonus in cash plus a box of chocolate which is worth $10.  How much is a taxable income on each employee? 

 

 

 

 

 

 

 

 

 

 

 

 

EXAMPLE 20 – IS THIS A TAXABLE INCOME?     

       1. Andy paints his neighbor’s house for a fair market value of $1,000, but in exchange the neighbor paves Andy’s driveway.  Is this $1,000 value of work a taxable income and deductible expense on Andy and his neighbor, respectively?  

 

       2. Brian borrowed $1,000 from his neighbor.  Later his neighbor forgives Brian’s debt, but Brian must paint his neighbor’s house in return.  Is this a taxable income on Brian and a deductible expense on his neighbor?

 

       3. On January 1, Year 1 Charles purchased $1,000 face value of New Jersey State bonds for a cost of $950 plus $10 commission.  On December 31, Year 1 he received $50 interest and immediately sold the entire bonds for a price of $990 in cash.  What is Charles’s taxable income and nontaxable income in Year 1? 

 

       4. Fred and Susan are divorced with a child, 10, living with Susan.  It was agreed that Fred will pay Susan $5,000 of support a year.  However, when the child reaches the age of 19, the support will reduce to $3,000 a year.  What is the deductible alimony on Fred and taxable alimony on Susan, respectively? 

 

       5. Ed is a college student on the Dean’s list.  He received $1,000 scholarship for his high grades, in which he spent $100 for tuition, $200 for books, and $700 for room and board.  Is there any taxable income on Ed?     

 

                                                                                                                                                                              5-13                                                                                                                                                                                                                                                                                                                                                                                                                               

                                                                                                                                                     

       6. Tom is an MBA student and also hired to work as a graduate assistant at a University.  He is required to work 15 hours a week to do research work for professors.  He received a $3,000 tuition waiver (remission) plus $4,000

 

       7. Jerry is a college student on the Dean’s list.  He received full tuition and fees waiver (remission) for his high grades.  He further received $1,000 of Chase Memorial Scholarship in cash.  Is there any taxable income on Jerry? 

 

       8. Ken’s car was hit by Larry’s truck.  As a result, Ken was hospitalized.  Larry’s insurance company paid

Ken $400 to fix up the car, $500 for his medical expense, $600 for his pain, and $700 for his lost wage for one week of absence from his work.  Is there any taxable income on Ken? 

 

       9. Mike joined his union strike and was dismissed by his employer.  He sued his employer and won.  The court reinstated his job and awarded him $1,000 for his lost wage during the walkout.  Is this a taxable income on Mike?

       10. Bill misused the name Exon Gasoline Company to sell gasoline.  Exxon Gasoline Company sued Bill for infringement of trademark and won.  As a result, the court awarded Exxon Gasoline Company $2,000 for lost profit and $1,000 punitive damage.  Is there any taxable income on Exxon Gasoline Company?

 

       11. Nelson spent $1,000 to build a garage.  A criminal burned it down.  The court awarded Nelson $1,100 compensation for the damage.  Is there any taxable income on Nelson? 

 

       12. Terry purchased a comprehensive medical insurance policy.  One day he fell from the ladder at home and could not go to work for one week.  His insurance company paid him $300 for medical expense and $500 of wage he lost during his injury. Is there any taxable income on Terry?

 

       13. Anderson Company purchased medical and disability insurance for all its employees.  Vincent, an employee, suffered heart attack and could not go to work for one week.  The insurance company paid him $300 for medical expense and $500 wage he lost during his illness.  Is there any taxable income on Vincent? 

                                                                                               

       14. Benson Company purchased medical and disability insurance for all its employee.  William, an employee as a painter, fell from the ladder on the job and could not go to work for one week.  The insurance company paid him $300 for medical expense and $500 for wage he lost during his injury.  Is there taxable income on William?. 

 

       16. Mother drove the car with daughter as a passenger.  The car got into accident.  The mother suffered physical injuries, but not the daughter except stress.  The insurance company paid $500 to the mother for physical injuries and $200 to the daughter for the stress by witnessing the mother’s physical injuries.  What is taxable?