Assignment 3

Chapter 4.

29.
Determine the taxpayers gross income for tax purposes in each of the following
situations:
a.

Deb, a cash basis taxpayer, traded a corporate bond with accrued interest of $300 for
corporate stock with a fair market value of $12,000 at the time of the exchange. Debs
cost of the bond was $10,000. The value of the stock had decreased to $11,000 by the end
of the year.

Ans:

At date of exchange: $12000- $1000-300 = $1700 Gross Income. The stock getting
decreased in value after the exchange is not relevant because she still owns the stock.
That means she has not realized the loss in value yet. Her gain is therefore $1700.

b.

Deb needed $10,000 to make a down payment on her house. She instructed her broker to
sell some stock to raise the $10,000. Debs cost of the stock was $3,000. Based on her
brokers advice, instead of selling the stock, she borrowed the $10,000 using the stock as
collateral for the debt.

Ans: Deb got a loan. Her liability increased. Her assets increased by the same amount. She used
stock as collateral for the debt and did not recognize an income. She continues to own the
stock. This implies the gross income is 0.
c.

Debs boss gave her two tickets to the Rabid Rabbits rock concert because she met her
sales quota. At the time she received the tickets, each ticket had a face price of $200 and
was selling on eBay for $300. On the date of the concert, the tickets were selling for $250
each. Deb and her son attended the concert.

Ans:

At the time she received the ticket the ticket was selling at $300/ticket. The time of
exchange matters. Hence her compensation income is $300x2 = $600.

Assignment 3
Q41.

Troy, a cash basis taxpayer, is employed by Eagle Corporation, also a cash basis taxpayer.
Troy is a full-time employee of the corporation and receives a salary of $60,000 per year.
He also receives a bonus equal to 10% of all collections from clients he serviced during
the year. Determine the tax consequences of the following events to the corporation and
to Troy:
a. On December 31, 2015, Troy was visiting a customer. The customer gave Troy a
$10,000 check payable to the corporation for appraisal services Troy performed during
2015. Troy did not deliver the check to the corporation until January 2016.

Ans: Services performed by an employee for the employers customers are considered
performed by the employer. In 2015, the corporations employee received (actually and
constructively receipt) the check of $10000 from the client for the corporation. This
income must be recognized as income for the cash basis corporation as it is equivalent to
cash actually received for the corporation. Thus, the employer is taxed on the income
from the services provided to the customer, and the employee is taxed on compensation
received from the employer - although Troy will recognize bonus only when it is actually
received, or when Troy is actually enriched, i.e. in 2015. The time Troy recognizes the
bonus has no bearing on when the employer actually is handed over the services fees
check - in this case 2016.
b. The facts are the same as in (a), except that the corporation is an accrual basis taxpayer
and Troy deposited the check on December 31, but the bank did not add the deposit to the
corporations account until January 2016.
Ans: Under the accrual method, an item is generally included in gross income for the year in
which it is earned, regardless of when it is collected. Tracy performed the services during
2015. So the income for the corporation is considered earned in 2015. For Troy, since
constructively receipt of the bonus doesnt take place until the bank has actually
deposited to the corporations account - since he is operating on cash basis. This means
Troy will recognize 10% bonus in 2016.
c. The facts are the same as in (a), except that the customer told Troy to hold the check
until January 2016 when the customer could make a bank deposit that would cover the
check.
Ans: Since the customer specifically told Troy that the cash to cover the check will not be
available until Jan.2016, the check cannot be treated as equivalent of cash. Since the
customer requests that the check not be cashed until a subsequent date, the income for
both employer and Troy is deferred until that later date, i.e. when check can be cashed,
i.e. 2016.

Assignment 3
Q53.

The LMN Partnership has a group term life insurance plan. Each partner has $150,000 of
protection, and each employee has protection equal to twice his or her annual salary.
Employee Alice (age 32) has $90,000 of insurance under the plan, and partner Kay (age
47) has $150,000 of coverage. Because the plan is a group plan, it is impossible to
determine the cost of coverage for an individual employee or partner.

a.

Assuming that the plan is nondiscriminatory, how much must Alice and Kay each include
in gross income as a result of the partnership paying the insurance premiums?

Ans:

Alice: For non-discriminatory plans, premiums on the first $50,000 of group term life
insurance protection are excludible from the employees gross income. For each $1,000
of coverage in excess of $50,000, Alice must include the amounts indicated in Exhibit 4.3
of text in gross income. i.e. for Alice,
Uniform Premium for $1000 of Group Term Life Insurance Protection= .08x12 = $0.96
In excess of 50000, this implies 90000-50000/1000 = 40
Alice must include = $0.96x40 = $38.4
Kay: Kay is not eligible for exclusion in group term life insurance since she is a partner.
She must include $1500.

b.

Assume that the partnership is incorporated. Kay becomes a shareholder and an employee
who receives a $75,000 annual salary. The corporation provides Kay with $150,000 of
group term life insurance coverage under a nondiscriminatory plan. What is Kays gross
income as a result of the corporation paying the insurance premiums?

Ans: Alice: For Alice, situation hasnt changed. Includible amount remains the same, $38.4
Kay: Kay is now eligible since partnership is incorporated. Kay must include:
0.15 x 12 x (150000-50000)/1000 = $180.
Q55.
a.

Linda and Don are married and file a joint return. In 2015, they received $12,000 in
Social Security benefits and $35,000 in taxable pension benefits and interest.
Compute the couples adjusted gross income on a joint return.
AGI =0.50[$35,000 + 0.50($12,000) - $32,000 ] + Pension benefits

Assignment 3
AGI = 4500+35000 = $39500

Don would like to know whether they should sell for $100,000 (at no gain or
loss) a corporate bond that pays 8% in interest each year and use the proceeds to buy a
$100,000 nontaxable State of Virginia bond that will pay $6,000 in interest each year.

b.

With corporate bond income with interest deducted, $35000 - $8000 = $27000
Plus, SS Benefits = 0.5[$27,000 + $6,000 + 0.5($12,000) $32,000] = $3500
Total AGI = $27,000+3500 = $30,500

Comparison as follows:

Case 1

Case 2

Other Income , Pension

benefits etc.

$35,000

$27,000

Taxable Social Security

benefits

4,500

3,500

$39,500

$30,500

Total AGI

Taxable Income Decrease by $9000. Interest Income is reduced and hence 15% marginal
tax also reduces economic income [2000 - (0.15x 9000)] = $650.

Assignment 3

c.

If Linda in (a) works part-time and earns $30,000, how much will Linda and Dons
adjusted gross income increase?
If Modified AGI plus one-half of Social Security benefits exceeds the second set of base
amounts, the taxable amount of Social Security benefits is the lesser of 1 or 2 below:
1.

.85(Social Security benefits). -> 0.85x(12000) = $10,200

2.

Sum of:
a. 0.85[MAGI + 0.50(Social Security benefits) - second base amount]
- > 0.85[$65,000+0.5(12,000)-44,000] = $22,950
, and
b. Lesser of:
Amount included through application of the first formula
$4,500 ($6,000 for married filing jointly).

Since, ($22,950+6000) > $10,200

Lesser amount is $10,200.
Therefore, the taxable amount of Social Security benefits = $10,200. Linda and Don
would be required to include 85% of the Social Security benefits $10,200 in their gross
income.
AGI = Other Income + Social security benefits = $65,000+ 10,200 = $75,200
Therefore, Increase in AGI = $75,200 - 39,500 = $35,700