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Exam 5: Gross Income: Exclusions

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Question 1

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Brooke works part-time as a waitress in a restaurant. For groups of seven or more customers, the customer is charged 15% of the bill for Brooke's services. For parties of less than seven, the tips are voluntary. Brooke received $11,000 from the groups of seven or more and $7,000 in voluntary tips from all other customers. Using the customary 15% rate, her voluntary tips would have been only $6,000. Brooke must include $18,000 ($11,000 + $7,000) in gross income.

A) True
B) False

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Question 2

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Benny loaned $100,000 to his controlled corporation. When it became apparent that the corporation would not be able to repay the loan in the near future, Benny canceled the debt. The corporation should treat the cancellation as a nontaxable contribution to capital.

A) True
B) False

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Question 3

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Under Swan Company's cafeteria plan, all full-time employees are allowed to select any combination of the following benefits, but the total received by each employee cannot exceed $8,000 a year. I. Group medical and hospitalization insurance for the employee, $3,600 a year. II) Group medical and hospitalization insurance for the employee's spouse and children, $1,200 a year. III) Child care payments, actual cost but not more than $4,800 a year. IV. Cash required to bring the total of benefits and cash to $8,000. Which of the following statements is true?

Bob had a terminal illness and realized that he "can't take it with him." Therefore, he cashed in his insurance policy and received $120,000. He had paid $50,000 in premiums on the policy. He used the money to fulfill his lifelong ambitions of going to the Super Bowl, driving an expensive sports car, and vacationing in Bermuda. Was Bob's behavior consistent with the Congressional intent in providing the tax exemption he was permitted to use?

Heather's interest and gains on investments for the current year are as follows: $\begin{array}{lr}\text { Interest on Madison County school bonds } & \$ 600 \\\text { Interest on U.S. government bonds } & 700 \\\text { Interest on a Federal income tax refund } & 200 \\\text { Gain on the sale of Madison County school bonds } & 500\end{array}$ Heather must report gross income in the amount of:

Ben was diagnosed with a terminal illness. His physician estimated that Ben would live no more than 18 months. After he received the doctor's diagnosis, Ben cashed in his life insurance policy and used the proceeds to take a trip to see relatives and friends before he died. Ben had paid $12,000 in premiums on the policy, and he collected $50,000, the cash surrender value of the policy. Henry enjoys excellent health, but he cashed in his life insurance policy to purchase a new home. He had paid premiums of $12,000 and collected $50,000 from the insurance company.

The employees of Mauve Accounting Services are permitted to use the copy machine for personal purposes, provided the privilege is not abused. Ed is the president of a civic organization and uses the copier to make several copies of the organization's agenda for its meetings. The copies made during the year would have cost $150 at a local office supply.

Barbara was injured in an automobile accident. She has threatened to file a suit against the other party involved in the accident and has proposed the following settlement: $\begin{array}{lr}\text { Damages for } 25 \% \text { loss of the use of her right arm } & \$ 200,000 \\\text { Medical expenses } & 30,000 \\\text { Loss of wages } & 10,000 \\\text { Punitive damages } & 100,000\\&&\$340,000\end{array}$ The defendant's insurance company is reluctant to pay punitive damages. Also, the company disputes the amount of her loss of wages. Instead, the company offers to pay her $300,000 for damages to her arm and $30,000 medical expenses. Assuming Barbara is in the 35% marginal tax bracket, will her after-tax proceeds from accepting the offer be equal to what she considers to be her actual damages (listed above)?

Theresa sued her former employer for age, race, and gender discrimination. She claimed $200,000 in damages for loss of income, $300,000 for emotional harm, and $500,000 in punitive damages. She settled the claim for $700,000. As a result of the settlement, Theresa must include in gross income:

On January 1, 2009, Cardinal Corporation issued 5% 25-year bonds at par and used the $12,000,000 proceeds to finance the construction of a new plant. On January 1, 2019, the company acquired the bonds on the open market for $11,500,000. Assuming that Cardinal is neither bankrupt nor insolvent, the acquisition and retirement of the bonds results in which of the following?

Cash received by an employee from an employer:

Gold Company was experiencing financial difficulties but was not bankrupt or insolvent. National Bank, which held a mortgage on other real estate owned by Gold, reduced the principal from $110,000 to $85,000. The bank had made the loan to Gold when it purchased the real estate from Silver, Inc. Pink, Inc., the holder of a mortgage on Gold's building, agreed to accept $40,000 in full payment of the $55,000 due. Pink had sold the building to Gold for $150,000 that was to be paid in installments over eight years. As a result of the above, Gold must:

Zack was the beneficiary of a life insurance policy on his deceased wife. Zack had paid $20,000 in premiums on the policy. He collected $50,000 on the policy when his wife died from a terminal illness. Because it took several months to process the claim, the insurance company paid Zack $53,000, the face amount of the policy plus $3,000 interest. Zack must include $23,000 in his gross income.

A U.S. citizen who works in France from February 1, 2019 until January 31, 2020 is eligible for the foreign earned income exclusion in 2019 and 2020.

Melody works for a company with only 22 employees. Her employer contributed $2,000 to her health savings account (HSA), and the account earned $100 in interest during the year. Melody withdrew only $1,200 to pay medical expenses during the year. Melody is not required to recognize any gross income from the HSA for the year.

Zork Corporation was very profitable and had accumulated excess cash. The company decided to repurchase some of its bonds that had been issued for $1,000,000. Because of an increase in market interest rates, Zork was able to retire the bonds for $900,000. The company is not required to recognize $100,000 of income from the discharge of its indebtedness but must reduce the basis in its assets.

A U.S. citizen worked in a foreign country for the period July 1, 2018 through August 1, 2019. Her salary was $10,000 per month. Also, in 2018 she received $5,000 in dividends from foreign corporations (not qualified dividends) . No dividends were received in 2019. Which of the following is correct?

Gull Corporation was undergoing reorganization under the bankruptcy laws. Its shareholders, who had made loans of $300,000 to the corporation, agreed to accept additional stock with a value of $200,000 instead of repayment on the debt. The Old Line Insurance Company, which had a $400,000 mortgage on the building, agreed to reduce the principal to $250,000. A trade creditor with a receivable of $150,000 from the company agreed to accept $70,000 in full payment for the debt incurred to purchase goods that were still on hand. Finally, the company transferred some equipment with an adjusted basis of $90,000 in satisfaction of a liability for $120,000. Compute the corporation's gross income and other adjustments necessary as a result of the above transactions.

A taxpayer incorrectly took a $5,000 deduction (e.g., incorrectly calculated depreciation) in 2019 and as a result, his taxable income was reduced by $5,000. The taxpayer discovered his error in 2020. The taxpayer must add $5,000 to his 2020 gross income in accordance with the tax benefit rule to correct for the 2019 error.

Iris collected $150,000 on her deceased husband's life insurance policy. The policy was purchased by the husband's employer under a group policy. Iris's husband had included $5,000 in gross income from the group term life insurance premiums during the years he worked for the employer. She elected to collect the policy in 10 equal annual payments of $18,000 each.