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  CHAPTER 3 1

Taxation

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CHAPTER 3

1.       What is the difference between earned income and unearned income?

 

         

2.       This chapter noted that returns on investment are taxable, whereas returns of investment are not taxable.  What is the conceptual basis for this treatment?  Cite examples of each type of return, and explain why they are or are not taxable.

 

         

 

3.       How does the wherewithal-to-pay concept affect the tax treatment of prepaid income?

 

         

4.       Under what circumstances can the following taxpayers defer recognition of prepaid income beyond the year of receipt?

 

a.   A cash basis taxpayer

 

         

 

b.   An accrual basis taxpayer

 

         

 

5.       Mitch travels extensively in his job as an executive vice president of Arthur Consulting Company.  During the current year, he used frequent flier miles that he had obtained during his business travel to take his family on a vacation to Europe.  The normal airfare for the trip would have been $6,000.

 

a.   Discuss whether Mitch has realized income from the use of the frequent flier miles for personal purposes.

 

         

 

 

b.   Will Mitch have to recognize any income from the use of the frequent flier miles?  Explain.

 

         

 

6.       In each of the following cases, determine who is taxed on the income:

 

a.   Camille owns several rental properties that produce $3,000 in income each month. Because of the age of the properties, Camille is concerned about her potential liability from accidents on the property. On June 1, she forms the CAM Rental Corporation and transfers ownership of the rental properties to the corporation. The tenants continue to pay Camille the monthly rent, which she deposits in her personal checking account.

 

         

 

b.   Jimbob owns royalty interests in several oil wells. On March 1, Jimbob instructs the payers of the royalties to pay half of each royalty payment to his son Joebob.

 

         

 

c.   Assume the same facts as in part b, except that on March 1, Jimbob gifts a half interest in each royalty contract to Joebob.

 

         

7.       Minnie owns a qualified annuity that cost $78,000.  The annuity is to pay Minnie $650 per month for life after she reaches age 65.  Minnie turns 65 on September 28, 2007, and receives her first payment on Nov. 1, 2007.

 

a.   How much gross income does Minnie have from the annuity payments she receives in 2007?

 

         

 

b.   Shortly after receiving her payment on October 1, 2022, Minnie is killed in an automobile accident.  How does the executor of Minnie's estate account for the annuity on her return for the year 2022?

 

         

 

 

c.   Assume that the accident does not occur until November 1, 2031.  How does the executor of Minnie's estate account for the annuity on her 2031 return?

 

         

8.       Devi is the chief executive officer of Nishida Limited.  Devi owns 20% of the common stock of Nishida.  During the current year, Devi’s salary is $60,000 and he receives a $30,000 bonus.  Nishida has taxable income of $200,000 and pays $80,000 in cash dividends.  How much gross income does Devi have if

 

a.   Nishida is a regular corporation?

 

         

 

b.   Nishida is an S corporation? 

 

         

9.       Hermano and Rosetta are a retired couple who receive $10,000 in Social Security benefits during the current year.  They also receive $3,000 in interest on their savings account and taxable pension payments of $28,000.  What is their gross income if

 

a.   They receive no other sources of income?

 

           

 

b.   They receive $13,000 in interest from tax-exempt bonds they owned?

 

         

 

10.     Will and Janine are divorced during the current year.  Will is to have custody of their two children and will receive their house as part of the divorce settlement.  The house, which Will and Janine bought for $60,000, is worth $100,000.  Janine is to receive one of their automobiles, for which they paid $21,000 and which is now worth $9,000.  Will will get the other automobile, which cost $6,000 and is worth $2,000.  Janine is to pay Will alimony of $900 per month.  However, the alimony payment is to be reduced $200 per month as each child reaches age 18 or if a child should die or marry before reaching age 18.  What are the tax effects of the divorce settlement for Will and Janine?

 

         

11.     Laura makes the following interest-free loans during the current year.  Discuss the income tax implications of each loan for both Laura and the borrower.  In all cases, the applicable federal interest rate is 8%.

 

a.   On April 15, Laura loans $30,000 to her brother Hyun to pay his income taxes.  Hyun is financially insolvent and has no sources of investment income.

 

         

 

b.   On March 1, Laura loans $12,000 to her secretary, George.  He uses the money as a down payment on a new house.

 

 

c.   On July 1, Laura loans her father $150,000.  He uses the money to buy a franchise to open a yogurt store.  He makes $5,000 on the yogurt store during the current year.

 

 

 

d.   On January 1, Laura loans $70,000 to Lotta, Inc.  She is the sole shareholder of Lotta, Inc., which is organized as a corporation.

 

 

12.     Reggie works during the summer for Dan the Screenman.  Dan pays Reggie $4,300 in salary, saves Reggie $200 on free screens for Reggie’s father’s house, and agrees to pay Reggie’s fall college tuition of $2,100.  How much gross income does Reggie have from this arrangement?

 

 

13.     Aziza is the sole owner of Azi's Fast Pizza.  During the current year, Azi's replaces its fleet of delivery vehicles.  Aziza's son purchases one of the old vehicles for $500, its tax basis to Azi's.  Similar vehicles are sold for $4,000.  What tax problem is posed by this situation? Explain who, if anyone, should report income from the transaction.

 

 

14.     Polly has the following capital gains and losses for the current year:

 

                                    Short-term capital gain                        $  1,000

                                    Short-term capital loss                8,000

                                    Long-term capital gain                            5,000

                                    Collectibles gain                                    16,000

                                    Collectibles loss                                      3,000

 

          What is the effect of the capital gains and losses on Polly's taxable income and her income tax liability?  Assume that Polly is in the 33% marginal tax rate bracket.

 

         

 

15.     Jennifer is single and has the following income and expenses:

 

Salary                                                     $76,000

Interest income                              5,000

Dividend income                                       9,000

Long-term capital gain                 10,000

Short-term capital loss                 14,000

Deductions for AGI                                  3,000

Deductions from AGI                   9,000

 

            Calculate Jennifer’s taxable income and income tax liability.

 

         

 

16.     Jawan has the following capital gains and losses in the current year:

 

               Short-term capital gain                        $     500

               Short-term capital loss                3,000

               Long-term capital gain                            6,000

               Long-term capital loss                         12,000

               Collectibles gain                                      2,000

 

          What is the effect of the capital gains and losses on Jawan's taxable income?

 

         

 

17.     Refer to problem 71.  In the following year, Jawan has the following capital gains and losses:

 

        Short-term capital loss                               $ 1,300

        Long-term capital gain                                  8,600

        Long-term capital loss                                  4,100

 

          What is the effect of the capital gains and losses on his taxable income?

 

         

 

18.     Ramona owns 20% of the stock of Miller, Inc.  Miller reports the following items for the current year:

 

Sales                                                                               $3,400,000

Gain on sale of stock held for 2 years                                250,000

Cost of goods sold                                                          1,800,000

Operating expenses                                                           900,000

Dividends paid to stockholders                                        180,000

 

          What are the effects on Ramona's taxable income if Miller, Inc. is organized as

 

a.   A corporation?

 

         

 

b.   An S corporation?

 

         

19.     During the last five months of the year, Dwana opens a new internet telecommunications business called Dwan-Com.  Dwan-Com bills $50,000 of revenues, but only receives $40,000 cash.  Dwan-Com incurs $3,000 of supply expenses and $41,000 of labor costs.  Dwan-Com pays for $2,200 of the supplies and $38,000 of the labor costs in the current year.

 

a.       What is Dwan-Com’s taxable income if it elects the cash method of accounting?

 

         

 

b.       What is Dwan-Com’s taxable income if it elects the accrual method of accounting?

 

         

 

c.       What method of accounting do you recommend that Dwan-Com elect?

 

 

20.     Arlene is a lawyer.  She begins the current year with $12,000 in accounts receivable from customers.  During the year, she bills customers $210,000 in fees and receives $180,000 in payments on account.  She writes off $8,000 of the receivables as uncollectible, leaving her a year-end receivable balance of $34,000.  What is Arlene's gross income if

 

a.   She uses the cash basis of accounting?

 

 

 

b.   She uses the accrual basis of accounting?

 

 

 

21.     How much income would an accrual basis taxpayer report in 2007 in each of the following situations?

 

a.   Toby's Termite Services Inc. provides monthly pest control on a contract basis.  Toby sells a 1-year contract for $600 and a 2-year contract for $1,080.  In October, Toby sells 10 1-year contracts and 5 two-year contracts.

 

 

b.   John's Tractor Sales receives a $150 deposit from a customer for a new tractor that the customer orders in December.  The tractor arrives the following February, at which time the customer pays the remaining $9,800 of the agreed-upon sales price.

 

c.   A customer of First Financial Lending sends First Financial two $600 checks in December in payment of December and January interest on a loan.

 

 

d.   First Financial Lending receives interest payments totaling $8,400 in January 2008 in payment of December 2007 interest on loans.