Whittenburg Gerald E., Altus-Buller Martha. Income Tax Fundamentals
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LO 2.1 2. John installed a new roof on his friend’s house in return for a used truck worth $8,000.
How much i ncome must Joh n report o n his tax return for his services? __________
___________________ ______________________________________________________
___________________ ______________________________________________________
_________________________________________________________________________
LO 2.1 3. Larry is a tax accountant and Sheila is a hairdresser. Larry prepares Sheila’s tax return
for free and Sheila agrees to style Larry’s hair six times for free in return fo r the tax
return. The value of the tax return is approximately $300 and the hair styling work
is approximately $300.
a. How much of the $300 is includable income to Larry? Why? ___________________
_________________________________ ______________________________________
_______________________________________________________________________
b. How much of the $300 is includable income to Sheila? Why? _________________
_______________________________________________________________________
________________________________________________________________________
LO 2.1 4. Kerry and Jim have a successful marijuana farm in the woods around Humboldt County,
California. Growing marijuana is illegal for federal purposes. Are Kerry and Jim required
by law to report the income from their farm on their tax return? Why? ______________
____________________________________________________________________________
_________________ ____________ ________ ____________ _____________ ____________ ___
LO 2.2 5. How are qualified dividends taxed in 2010? Please give the two rates of tax which apply
to qualified dividends, and when each of these rates applies. ______________
_________________________________________________________________________
_________________________________________________________________________
LO 2.2 6. If a taxpayer holding Series EE Bonds does not make an election with respect to the tax-
ation of the bonds, how is the interest that accrues each year on the bonds taxed?
__________________________________________________________________________
_________________________________ ________________________ ____________________
LO 2.2 7. Sally and Charles Heck received the following dividends and interest during 2010:
Sally Charles Jointly
Qualifying dividends:
General Motors $850
IBM $2,100
Gene Corporation $3,250
Wilson Corporation 750
Interest:
Dime Box Bank 1,250
First National Bank 750
Assuming the Hecks file a joint tax return, complete Schedule B of Form 1040 (on
page 2-33) for them for the 2010 tax year. Do not attempt to complete the Qualified
Dividends and Capital Gain Tax Worksheet.
Questions and Problems 2-31
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LO 2.2 8. Answer the following questions, assuming that the related divorce agreements were
executed during 2010.
a. Under a divorce agreement, Joan is required to pay her ex-husband, Bill, $700 a
month until their daughter is 18 years of age. At that time, the required payments
are reduced to $500 per month.
1. How much of each $700 payment may be deducted as alimony by Joan?
$ ____________
2. How much of each $700 payment must be included in Bill’s taxable income?
$ ____________
b. Under the terms of a property settlement executed during 2010, Jane transferred
property worth $500,000 to her ex-husband, Tom. The property has a tax basis
to Jane of $400,000.
1. How much taxable gain must be recognized by Jane at the time of the transfer?
$ ____________
2. What is the amount of Tom’s tax basis in the property he received from Jane?
$ ____________
LO 2.2 9. Arlen is required by his divorce agreement to pay alimony of $2,000 a month and child
support of $2,000 a month to his ex-wife Jane. What is the tax treatment of these two
payments for Arlen? What is the tax treatment of these two payments for Jane?
Arlen ________________________________________________________________
_______________________________________________________________________
Jane _________________________________________________________________
_______________________________________________________________________
LO 2.2 10. As part of the property settlement related to their divorce, Cindy must give Allen the house
that they have been living in, while she gets 100 percent of their savings accounts. The
house was purchased for $100,000 15 years ago in Southern California and is now worth
$500,000. How much gain must Cindy recognize on the transfer of the house to Allen?
What is Allen’s tax basis in the house for calculating tax on any future sale of the house?
Cindy _______________________________________________________________
_______________________________________________________________________
Allen _____________________________________ ________ ________________ ___
_______________________________________________________________________
LO 2.2 11. How m uch of each of the following prizes or awards is taxable?
a. Cheline received a $50,000 gift bag at the Oscars in 2010.
b. Jon received a gold watch worth $350 for 25 years of service to his accounting firm.
c. Kerry won $1,000,00 0 in her state lottery.
d. Deborah is a professor who received $50,000 as an award for her scientific research
from the University that employs her.
LO 2.2
LO 2.4
12. For each of the following independent cases, indicate the amount of gross income that
must be included on the taxpayer’s 2010 income tax return.
a. Malchia won a $4,000 humanitarian award.
$ ____________
b. Rob w on a new automobile (with a window sticker price of $15,700 and a market
value of $14,500) for being the best junior tennis player in 2010.
$ ____________
c. George received a $3,500 room and board scholarship to attend Western University.
$ ____________
2-32 Chapter 2
Gross Income and Exclusions
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Questions and Problems 2-33
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2-34 Chapter 2
Gross Income and Exclusions
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
LO 2.3 13. Yolanda purchased an annuity for $200,000 which pays her $18,000 per year for life. At
the date of purchase, her life expectancy is 15 years. If she receives $18,000 in the cur-
rent year, what amount is excluded from her gross income using the general rule for
annuities?
$ ____________
LO 2.3 14. Teresa retired in June of 2010, with a life expectancy of 10 years. Her pension is $1,400
per month from a qualified pension plan to which her employer also made contribu-
tions. Teresa contributed $28,000 to the plan. In 2010, Teresa received five payments
for a total of $7,000. Calculate Teresa’s taxable portion of the pension for 2010 using
the general rule.
$ ____________
LO 2.4 15. Sharon transfers to Russ a life insurance policy with a cash surrender value of $30,000
and a face value of $100,000 in exchange for real estate. Russ continues to pay
the premiums on the policy until Sharon dies 7 years later. At that time, Russ has
paid $14,000 in premiums, and he collects the $100,000 face value. How much of
the proceeds is taxable to Russ?
$ ____________
Why? _______________________________________________________________
_______________________________________________________________________
LO 2.4 16. Greg died on July 1, 2010, and left Lea, his wife, a $50,000 life insurance policy which
she elects to receive at $5,000 per year plus interest for 10 years. In the current year,
Lea receives $6,200. How much should Lea include in her gross income?
$ ____________
LO 2.4 17. David is certified by his doctor as terminally ill with liver disease. His doctor certifies
that he cannot be reasonably expected to live for more than a year. He sells his life
insurance policy to Viatical Settlements, Inc., for $250,000. He has paid $20,000 so
far for the policy. How much of the $250,000 must David include in his taxable
income? ___________ ___________ _______ __________ ___________ ___________ __
__________________________________________________________________________
LO 2.4 18. In June of 2010, Kevin inherits stock worth $125,000. During the year, he collects
$7,500 in dividends. How much of these amounts, if any, should Kevin include in
his gross income for 2010?
$ ____________
Why? _______________________________________________________________
_______________________________________________________________________
LO 2.4 19. Helen receives a $200,000 lump sum life insurance payment when her friend Alice dies.
How much of the payment is taxable to Helen? ____________________________
______________________________________________ _____________________________
LO 2.4 20. Gwen is a tax accountant who works very hard for a large corporate client. The client is
pleased and gives her a gift of $10,000 at year-end. How much of the gift is taxable to
Gwen? ___________________________ _____________________________________
______________________________________________ _____________________________
Questions and Problems 2-35
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
LO 2.4 21. Charlene receives a gift from her boyfriend of $10,000. He knows she is having
financial problems and wants to help her. How much of the gift is taxable to
Charlene? _____________________________________________________________
________________________________________________________________________
LO 2.4 22. Ellen is a single taxpayer. Ellen’s employer pays $150 per month ($1,800 this year) for
her health insurance. During the year, Ellen had medical expenses of $3,500 and the
insurance company paid $2,000 of the expenses. How much of the above amounts,
if any, must be included in Ellen’s gross inc ome?
$ ____________
Why? _______________________________________________________________
_______________________________________________________________________
LO 2.2 23. Lydia, a married individual, was unemployed for a few months during 2010. Dur-
ing the year, she received $3,250 in unemployment compensation payments. How
much of her unemployment compensation payments must be included in gross
income?
$ ____________
LO 2.4 24.
a. Milton is a nurse whose employer provided meals for him on the employer’s prem-
ises, since he is given only 30 minutes for lunch. Is the value of these meals taxable
income to Milton?
Explain _______________________________________________________________
_______________________________________________________________________
b. Mary is a San Diego ambulance driver. The City provides Mary with meals while she
is working so she will be available for emergencies. Is the value of these meals taxable
income to Mary?
Explain _______________________________________________________________
_______________________________________________________________________
LO 2.4 25. Robbie receives a scholarship of $20,000 to an elite private college. $10,000 of the
scholarship is earmarked for tuition, and $10,000 covers his room and board. How
much of the scholarship, if any, is taxable to Robbie? _________________ _________
___________________________________________________________________________
LO 2.4 26. Skyler is covered by his company’s health in surance plan. The health insurance costs
his company $3,500 a year. During the year, Skyler is diagnosed with a serious illness
and the health insurance pays $100,000 for surgery and treatment. How much of the
insurance and trea tment costs are taxable to Skyler? _________________________
__________________________________________________________________________
LO 2.4 27. Vandell is a taxpayer in the 28 percent tax bracket. He invests in Otay Mesa Water
District Bonds that pay 6 percent interest. What taxable interest rate will provide
the same after-tax return to Vandell?
____________ %
2-36 Chapter 2
Gross Income and Exclusions
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
LO 2.5 28. During the 2010 tax year, Brian, a single taxpayer, received $6,000 in Social Security
benefits. His adjusted gross income for the year was $18,000 (not including the Social
Security benefits) and he received $30,000 in tax-exempt interest income. Calculate the
amount of the Social Security benefits that Brian must include in his gross income
for 2010.
Simplified Taxable Social Security Worksheet (for most people)
1. Enter the total amount of Social Security income. 1. _______
2. Enter one-half of line 1. 2. _______
3. Enter the total of taxable income items on Form 1040
except Social Security income.
3. _______
4. Enter the amount of tax-exempt interest income. 4. _______
5. Add lines 2, 3, and 4. 5. _______
6. Enter all adjustments for AGI except for student loan
interest, the domestic production activities deduction,
and the tuition and fees deduction.
6. _______
7. Subtract line 6 from line 5. If zero or less, stop here,
none of the Social Security benefits are taxable.
7. _______
8. Enter $25,000 ($32,000 if married filing jointly; $0 if
married filing separately and living with spouse at any
time during the year).
8. _______
9. Subtract line 8 from line 7. If zero or less, enter –0–. 9. _______
Note: If line 9 is zero or less, stop here; none of your
benefits are taxable. Otherwise, go on to line 10.
10. Enter $9,000 ($12,000 if married filing jointly; $0 if mar-
ried filing separately and living with spouse at any time
during the year).
10. _______
11. Subtract line 10 from line 9. If zero or less, enter –0–. 11. _______
12. Enter the smaller of line 9 or line 10. 12. _______
13. Enter one-half of line 12. 13. _______
14. Enter the smaller of line 2 or line 13. 14. _______
15. Multiply line 11 by 85% (.85). If line 11 is zero, enter –0–. 15. _______
16. Add lines 14 and 15. 16. _______
17. Multiply line 1 by 85% (.85). 17. _______
18. Taxable benefits. Enter the smaller of line 16 or line 17. 18. _______
LO 2.4 29. Linda and Richard are married and file a joint return for 2010. During the year, Linda,
who works as an accountant for a national airline, used $2,100 worth of free passes for
travel on the airline; Richard used the same amount. Linda and Richard also used $750
worth of employee discount coupons for hotel rooms at the hotel chain that is also
owned by the airline. Richard is employed at State University as an accounting
clerk. Under a tuition reduction plan, Richard saved $1,000 in tuition fees during
2010. He is stu dying for a master’s degree in business. Richard also had $30 worth
of personal typing done by his secretary at the University. W hat is the amount of
Questions and Problems 2-37
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
fringe benefits that should be included in Linda and Richard’s gross income on their
2010 tax return?
$ ____________
LO 2.5 30. Please answer the following questions regarding the taxabi lity of Social Security:
a. A 68-year-old taxpayer has $20,000 in Social Security income and $100,000 in tax-free
municipal bond income. Does the municipal bond income affect the amount of Social
Security the taxpayer must include in income? ______________________________
__________________ ______ __ ______ _____ ______ _____ ______ _____ ______ _____ ____
b. A 68-year-old taxpayer has $20,000 in Social Security income and no other taxable
or tax-free income. How much of the Social Security income must the taxpayer
include in taxable income? _____________________________________________
______________________________________________________________________
________________________________________________________________________
c. A 68-year-o ld taxpayer has $20,000 in Social Security income and has significant
other taxable retirement income. What is the maximum percentage of Social Security
that the taxpayer might be required to include in taxable income? ___________
________________________________________________________________________
_________________________________________________________________________
LO 2.3 31. Lola, age 62, began receiving a $2,000 monthly annuit y i n t he current year upon the
death of her husband. She received eight payments in the current year. Her husband
contributed $40,000 to the qualified employee plan. Use the Simplified Method
Worksheet below to calculate Lola’s taxable amount from the annuit y.
Simplified Method Worksheet
1. Enter total amount received this year. 1. ____________
2. Enter cost in the plan at the annuity starting date. 2. ____________
3. Age at annuity starting date
Enter
55 and under 360
56–60 310
61–65 260 3. ____________
66–70 210
71 and older 160
4. Divide line 2 by line 3. 4. ____________
5. Multiply line 4 by the number of monthly payments
this year. If the annuity starting date was before
1987, also enter this amount on line 8, and skip lines
6 and 7. Otherwise, go to line 6.
5. ____________
6. Enter the amount, if any, recovered tax free in prior
years.
6. ____________
2-38 Chapter 2
Gross Income and Exclusions
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
7. Subtract line 6 from line 2. 7. ____________
8. Enter the smaller of line 5 or 7. 8. ____________
9. Taxable amount this year: Subtract line 8 from line 1.
Do not enter less than zero.
9. ____________
LO 2.4 32. Ellen’s tax client is employed at a lar ge company that offers medical flexible spending
accounts to its employees. Tom must decide at the beginning of the year whether he
wants to put as much as $5,000 of his salary into the medical spending account. He
expects that he will have to p ay for at least $8,000 of medical expenses for his family
during the year since his wife is see ing a psychiatrist every week and his daughter and
son are both having their teeth straighten ed. Tom does not itemize deductions.
Should Ellen recommend that Tom put the maximum in his medical flexible spending
account, and if so, why? _________________________________________________
_____________________________________________________ __________________
___________________ ____________________________ _________________________
___________________________________________________________ ________________
LO 2.4 33. Karen is a well-off retired investment advisor who is in the 35 percent tax bracket. She
has a choice between investing in a high-quality municipal bond paying 5 percent or a
high-quality corporate bond paying 7 percent. Which investment do you think she will
make and why? ____________________________________________________________
________________________________________________________________________
__________________________________________________________________________
34. Go to the IRS Web site (www.irs.gov) and print out a copy of Worksheet 1. Recapture of
Alimony in the most recent IRS Publication 504, Divorced or Separated Individuals.
35. Go to the IRS Web site (www.irs.gov) and redo Prob lem 7 (Chapter 2, Group 2)
using the most recent interactive ‘‘Fill-in Forms’’ Schedule B. Print out the completed
Schedule B.
GROUP 3:
COMPREHENSIVE PROBLEMS
.............................................. .............................................. .
1. Bev and Ken Hair have been married for 3 years. They live at 3567 River Street,
Springfield, MO 63126. Ken is a full-time student at Southwest Missouri State Univer-
sity (SMSU) and Bev works as an accountant at Cypress Corporation. Bev’s Social
Security number is 465-74-3321 and Ken’s is 465-57-9934. Bev’s earnings and income
tax withhold ings for 2010 are:
Earnings from Cypress Corp. $50,000
Federal income tax withheld 5,500
State income tax withheld 675
Questions and Problems 2-39
Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
The Hairs have interest income of $1,000 on City of St. Louis bonds. During 2010,
Bev and Ken received the following 1099-INT and DIV:
Boatman’s Bank
300 City Avenue
Springfield, MO 63126
577
XX-XXXXXXX
465-57-9934
Ken & Bev Hair
3567 River Street
Springfield, MO 63126
Green Corporation
900 South Orange Ave
Springfield, MD 63126
287
287
XX-XXXXXXX
465-57-9934
Ken & Bev Hair
3567 River Street
Springfield, MO 63126
Ken is an excellent student at SMSU. He was given a $1,750 scholarship by the Uni-
versity to help pay educational expenses. The scholarship funds were used by Ken for
tuition and books. Ken also had a part-time job at SMSU. He was paid $2,525 on a
W-2 for helping out in the Dean’s office. There was no income tax with held on the
amount paid to Ken from this job.
Last year, Bev was laid off from her former job and was unemployed during January
2010. She was paid $1,825 of unemployment compensation until she started work
with her current employer, Cypress Corporation.
Ken has a 4-year-old son, Robert R. Hair, from a prior marriage. During 2010,
he paid his ex-wife $300 per month in child support. Robert is claimed as a dependent
by Ken’s ex-wife.
2-40 Chapter 2
Gross Income and Exclusions
Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.