South Western Federal Taxation 2013 Individual Income Taxes 36th Edition by Hoffman Smith Solutions Manual Test Bank

South Western Federal Taxation 2013 Individual Income Taxes 36th Edition by Hoffman Smith Solutions Manual Test Bank -- price  $35

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Contents of Appendix E
Problem 1 – Karl F. and Jeanne S. Wheat – Individual Income Tax Return
Problem 2 – Robert (Bob) S. and Sally D. Grove – Individual Income Tax Return
Problem 3 – Pet Kingdom – Form 1120 Corporate Tax Return
Problem 4 – By the Numbers – Form 1120 Corporate Tax Return
Problem 5 – Rock the Ages – Form 1065 tax return
Problem 6 – Chocolat, Inc – Form 1120S
Problem 7 – Daniel and Lisa Ward – Form 709 Tax Returns
Problem 8 – Pam Butler – Form 706 Tax Return
Problem 9 – Green – Form 1041 Tax Return


1. LO.2 Uncle Tom promised John, “Come and take care of me, and I will leave you the farm when I die.” John took care of Uncle Tom for the five years preceding his death. When Uncle Tom died, in accordance with his will, John received the farm. Can John exclude the value of the farm from his gross income as a gift or inheritance, or has he received compensation income?

2. LO.2 Leonard’s home was damaged by a fire. He also had to be absent from work for several days to make his home habitable. Leonard’s employer paid Leonard his regular salary, $2,500, while he was absent from work. In Leonard’s pay envelope was the following note from the employer: To help you in your time of need. Leonard’s fellow employees also took up a collection and gave him $900. Leonard spent over $4,000 repairing the fire damage. Based on the above information, how much is Leonard required to include in his gross income?

3. LO.1, 2 Twenty college fraternity brothers each placed $2,500 in a mutual fund account. They agreed that upon the death of a fraternity brother, his beneficiary would receive $20,000 that was to be paid from the mutual fund account. The beneficiary of the last remaining fraternity brother would receive the balance remaining in the account. The mutual fund did very well. Earl was the last to die, at age 92, and his beneficiary received $250,000. Can the $250,000 be excluded from the beneficiary’s gross income? 

4. LO.2 Janice was a cash basis taxpayer. At the time of her death, she was owed $100,000 in accrued salary. Upon Janice’s death, the employer was required to pay Wayne, Janice’s brother, her accrued salary. Janice was a key employee, and her employer had purchased a $1,000,000 insurance policy on her life, with the proceeds payable to the employer. Her employer had paid $300,000 in premiums when it collected the face amount of the policy. What amount must be included in the gross income of Janice, Wayne, and Janice’s employer?

5. LO.2 Dolly is a college student who works as a part-time server in a restaurant. Her usual tip is 20% of the price of the meal. A customer ordered a piece of pie and said that he would appreciate prompt service. Dolly abided with the customer’s request. The customer’s bill was $8, but the customer left a $100 bill on the table and did not ask for a receipt. Dolly gave the cashier $8 and pocketed the $100 bill. Dolly concludes that the customer thought that he had left a $10 bill, although the customer did not return to correct the apparent mistake. The customer had commented about how much he appreciated Dolly’s prompt service. Dolly thinks that a $2 tip would be sufficient and that the other $98 is like “found money.” How much should Dolly include in her gross income?

6. LO.2 Carey is a self-employed landscaper. He contracted to maintain Ted’s lawn for $150 per month. Ted was very pleased with Carey’s work and at the end of the year paid Carey an additional $500. Does the fact that Ted had no legal obligation to make the payment mean that Carey can exclude the $500 from gross income as a gift? Explain

7. LO.2 Lime Finance Company requires its customers to purchase a credit life insurance policy associated with the loans it makes. Lime is the beneficiary of the policy to the extent of the remaining balance on the loan at the time of the customer’s death. In 2011, Lime wrote off as uncollectible a $5,000 account receivable from Wally, which included $1,500 of accrued interest. When Wally died in 2012, the life insurance policy was still in force and Lime received $3,500. Is the $3,500 of life insurance proceeds received by Lime included in its gross income? Explain.

8. LO.2 Sarah, who has a terminal illness, cashed in her life insurance policy (cost of $24,000 and proceeds of $50,000) to go on an around-the-world cruise. Ed paid $24,000 of life insurance premiums before cashing in his life insurance policy for the $50,000 cash surrender value. He decided he could invest the money and earn a higher rate of return. Tom’s wife died, and Tom collected $50,000 as the beneficiary on a group term life insurance policy purchased by her employer. Determine the amounts that Sarah, Ed, and Tom should include in their gross income.

9. LO.2 Joe is a graduate student who works as a resident adviser (RA) in the college dormitory. As compensation for serving as an RA, he is not charged the $2,200 other students pay for their dormitory rooms for the fall 2012 semester. As an RA, he is required to live in the dormitory. He is also paid $1,500 for being available to dormitory residents at all hours during the fall semester. Joe also has a scholarship that pays him $12,000 to be used for his tuition for the academic year. He uses the scholarship proceeds to pay $6,000 of tuition in August 2012. In January 2013, he pays $6,000 for his spring semester tuition. What is Joe’s gross income for 2012?

10. LO.2 Billy fell off a bar stool and hurt his back. As a result, he was unable to work for three months. He sued the bar owner and collected $100,000 for the physical injury and $50,000 for the loss of income. Billy also collected $15,000 from an income replacement insurance policy purchased by his employer. Amber was away from work for three months following heart bypass surgery. Amber collected $30,000 under an income replacement insurance policy she had purchased. Are the amounts received by Billy and Amber treated the same under the tax law? Explain.

11. LO.2 Wes was a major league baseball pitcher who earned $10 million for his 20 wins this year. Sam was also a major league baseball pitcher before a career-ending injury caused by a negligent driver. Sam sued the driver and collected $6 million as compensation for lost estimated future income as a pitcher and $4 million as punitive damages. Do the amounts that Wes and Sam receive have the same effect on their gross income? Explain.

12. LO.2 Holly was injured while working in a factory and received $12,000 as workers’ compensation while she was unable to work because of the injury. Jill, who was selfemployed, was also injured and unable to work. Jill collected $12,000 on an insurance policy she had purchased to replace her loss of income while she was unable to work. How much are Holly and Jill each required to include in their gross income?

13. LO.2 Melba’s employer provides a flexible spending plan for medical and dental expenses not covered by insurance. Melba contributed $1,500 during 2012, but by the end of December 2012, she still had $300 remaining in the account. Melba intended to get new eyeglasses, but was too busy during the holiday season. Is Melba required to forfeit the balance in her flexible spending account? Explain.

14. LO.2, 5 Casey is in the 15% marginal tax bracket, and Jean is in the 35% marginal tax bracket. Their employer is experiencing financial difficulties and cannot continue to pay for the company’s health insurance plan. The annual premiums are approximately $7,000 per employee. The employer has proposed to either (1) require the employee to pay the premiums or (2) reduce each employee’s pay by $8,000 per year with the employer paying the premium. Which option is less objectionable to Casey, and which is less objectionable to Jean?

15. LO.2 What is the difference between a cafeteria plan and an employee flexible spending plan?

16. LO.2 Ted works for Azure Motors, an automobile dealership. All employees can buy a car at the company’s cost plus 2%. The company does not charge employees the $300 dealer preparation fee that nonemployees must pay. Ted purchased an automobile for $29,580 ($29,000 + $580). The company’s cost was $29,000. The price for a nonemployee would have been $33,900 ($33,600 + $300 preparation fee). What is Ted’s gross income from the purchase of the automobile?

17. LO.2, 5 Wilbur has been offered a job where his salary would be $150,000 and he would also receive health insurance coverage. Another potential employer has offered to match the first offer but would not provide any health insurance coverage. Wilbur can purchase health insurance for $8,000 per year. Assume that Wilbur is in the 28% marginal tax bracket and does not itemize his deductions. How much salary must the second potential employer pay so that Wilbur’s financial status will be the same under both offers?

18. LO.2, 5 Eagle Life Insurance Company pays its employees $.30 per mile for driving their personal automobiles to and from work. The company reimburses each employee who rides the bus $100 a month for the cost of a pass. Tom collected $100 for his automobile mileage, and Mason received $100 as reimbursement for the cost of a bus pass.
a. What are the effects of the above on Tom’s and Mason’s gross income?
b. Assume that Tom and Mason are in the 28% marginal tax bracket and the actual before-tax cost for Tom to drive to and from work is $.30 per mile. What are Tom’s and Mason’s after-tax costs of commuting to and from work?

19. LO.2 Several of Egret Company’s employees have asked the company to create a hiking trail that employees could use during their lunch hours. The company owns vacant land that is being held for future expansion but would have to spend approximately $50,000 if it were to make a trail. Nonemployees would be allowed to use the facility as part of the company’s effort to build strong community support. What are the relevant tax issues for the employees?

20. LO.2 The Sage Company has the opportunity to purchase a building located next to its office. Sage would use the building as a day care center for the children of its employees and an exercise facility for the employees. Occasionally, portions of the building could be used for employees’ family events such as reunions, birthday parties, and anniversaries. The company would like to know if the planned uses of the building would fit into a beneficially taxed employee compensation plan.

21. LO.2 Brad is a single individual with $25,000 in taxable interest income and a salary of $86,000 from working in a foreign country for the past 12 months. What tax rate is applied to Brad’s taxable income in 2012?

22. LO.2, 5 Tammy, a resident of Virginia, is considering purchasing a corporate bond that yields 7% before tax. She is in the 35% Federal marginal tax bracket and the 5% marginal state tax bracket. She is aware that State of Virginia bonds of comparable risk are yielding 4.6% and State of North Carolina bonds are yielding 4.7%. Which of the three options will provide the greatest after-tax return to Tammy?

23. LO.3 Zack is a farmer who buys his feed and fertilizer from a farmer’s cooperative. In 2011, Zack purchased $300,000 in feed and fertilizer for the farm and $10,000 of household goods. Because the cooperative made a profit in 2011, it distributed to its members 2% of their purchases. Zack received his share of the distribution, $6,200, in March 2012. What is Zack’s gross income from the distribution?

24. LO.2 Andrea entered into a § 529 qualified tuition program for the benefit of her daughter, Joanna. Andrea contributed $15,000 to the fund. The fund balance had accumulated to $25,000 by the time Joanna was ready to enter college. However, Joanna received a scholarship that paid for her tuition, fees, books, supplies, and room and board. Therefore, Andrea withdrew the funds from the § 529 plan and bought Joanna a new car. a. What are the tax consequences to Andrea of withdrawing the funds? b. Assume instead that Joanna’s scholarship did not cover her room and board, which cost $7,500 per academic year. During the current year, $7,500 of the fund balance was used to pay for Joanna’s room and board. The remaining amount was left in the § 529 plan to cover her room and board for future academic years. What are the tax consequences to Andrea and to Joanna of using the $7,500 to pay for the room and board?

25. LO.3 Molly is a cash basis taxpayer. In 2012, she earned only $6,500, which was less than her standard deduction and personal exemption. In January 2013, Molly’s employer determined that he had miscalculated her December 2012 bonus and that she should have received an additional $1,000 of compensation in 2012. The employer paid Molly the $1,000 in 2013. If Molly had received the $1,000 in 2012, it would not have resulted in any tax liability because her gross income would still have been less than her standard deduction and personal exemption. In 2013, Molly had over $30,000 in taxable income. Does the tax benefit rule apply to Molly’s situation? Explain.

26. LO.4 Harry was experiencing financial difficulties and could not make the mortgage payments on his property. The mortgage holder agreed to reduce the debt principal by $50,000 because the real estate market was depressed. Assuming that Harry is not bankrupt or insolvent, would the tax consequences differ under the following circumstances? Explain. 

The mortgage is held by the person who sold him the property. 

The mortgage is on farmland that was held by a bank that loaned the money so that Harry could purchase the land. 

The mortgage is on his personal residence and is held by the financial institution that made the loan for the purchase of his residence. 

Harry’s debt was reduced because the mortgage holder, a bank, held a drawing that Harry won; the prize was a $50,000 reduction in his mortgage.

27. LO.4 Ralph has experienced financial difficulties as a result of his struggling business. He has been behind on his mortgage payments for the last six months. The mortgage holder, who is a friend of Ralph’s, has offered to accept $80,000 in full payment of the $100,000 owed on the mortgage and payable over the next 10 years. The interest rate of the mortgage is 7%, and the market rate is now 8%. What tax issues are raised by the creditor’s offer?


28. LO.2 Ed, an employee of the Natural Color Company, suffered from a rare disease that was very expensive to treat. The local media ran several stories about Ed’s problems, and the family received more than $10,000 in gifts from individuals to help pay the medical bills. Ed’s employer provided hospital and medical insurance for its employees, but the policy did not cover Ed’s illness. When it became apparent that Ed could not pay all of his medical expenses, the hospital canceled the $25,000 Ed owed at the time of his death. After Ed’s death, his former employer paid Ed’s widow $12,000 in “her time of need.” Ed’s widow also collected $50,000 on a group term life insurance policy paid for by Ed’s employer. What are Ed’s and his widow’s gross income?

29. LO.2 Determine the gross income of the beneficiaries in the following cases:
 a. Justin lost his job when his employer moved the plant to China. His employer gave Justin $15,000 to help him in his transition to a new job, even though the employer was not legally obligated to make the payment.
b. Trina was injured while working. She collected $1,200 in workers’ compensation and $1,500 on a loss of income policy she had purchased.
c. Coral Corporation collected $1 million on a key person life insurance policy when its chief executive died. The corporation had paid the premiums on the policy of $77,000.
d. Juan collected $50,000 on a life insurance policy when his wife, Leona, died. The policy was provided by Leona’s employer, and the premiums were excluded from Leona’s gross income as group term life insurance.
e. Juan in part (d) collected Leona’s accrued vacation pay of $6,000 from her employer.

30. LO.2, 5 Laura was recently diagnosed with cancer and has begun chemotherapy treatments. A cancer specialist has stated that Laura has less than one year to live. She has incurred a lot of medical bills and other general living expenses and is in need of cash. Therefore, she is considering selling stock that cost $35,000 and has a fair market value of $50,000. This amount would be sufficient to pay her medical bills. However, she has read about a company (the Vital Benefits Company) that would purchase her life insurance policy for $50,000. She has paid $30,000 in premiums on the policy. a. Considering only the tax effects, would selling the stock or selling the life insurance policy result in more beneficial tax treatment? b. Assume that Laura is a dependent child and that her mother owns the stock and the life insurance policy, which is on the mother’s life. Which of the alternative means of raising the cash would result in more beneficial tax treatment?

31. LO.2 What is the taxpayer’s gross income in each of the following situations? a. Darrin received a salary of $50,000 in 2012 from his employer, Green Construction. b. In July 2012, Green gave Darrin an all-expense-paid trip to Las Vegas (value of $3,000) for exceeding his sales quota. c. Megan received $10,000 from her employer to help her pay medical expenses not covered by insurance. d. Blake received $15,000 from his deceased wife’s employer “to help him in his time of greatest need.” e. Clint collected $50,000 as the beneficiary of a group term life insurance policy when his wife died. The premiums on the policy were paid by his deceased wife’s employer.

32. LO.2 Donald was killed in an accident while he was on the job in 2012. At the time of his death, he had $40,000 in an accrued bonus that was paid to his wife, Darlene. His employer had provided Donald with group term life insurance of $240,000 (twice his annual salary), which was payable to his widow, Darlene, in a lump sum. Premiums on this policy totaling $4,500 had been included in Donald’s gross income under § 79. Donald’s employer also paid Darlene an amount equal to Donald’s three months’ salary of $30,000, which is what the employer does for all widows and widowers of deceased employees. Donald had purchased a life insurance policy (premiums totaled $70,000) that paid $200,000 in the event of accidental death. The proceeds were payable to Darlene, who elected to receive installment payments as an annuity of $20,000 each year for a 25-year period. She received her first installment this year. From the above information, what is Darlene’s gross income in 2012?

33. LO.2 Ray and Carin are partners in an accounting firm. The partners have entered into an arm’s length agreement requiring Ray to purchase Carin’s partnership interest from Carin’s estate if she dies before Ray. The price is set at 120% of the book value of Carin’s partnership interest at the time of her death. Ray purchased an insurance policy on Carin’s life to fund this agreement. After Ray had paid $45,000 in premiums, Carin was killed in an automobile accident and Ray collected $800,000 of life insurance proceeds. Ray used the life insurance proceeds to purchase Carin’s partnership interest.

a. What amount should Ray include in his gross income from receiving the life insurance proceeds?

b. The insurance company paid Ray $16,000 interest on the life insurance proceeds during the period Carin’s estate was in administration. During this period, Ray had left the insurance proceeds with the insurance company. Is this interest taxable?

c. When Ray paid $800,000 for Carin’s partnership interest, priced as specified in the agreement, the fair market value of Carin’s interest was $1 million. How much should Ray include in his gross income from this bargain purchase?

34. LO.2 Sally was an all-state soccer player during her junior and senior years in high school. She accepted an athletic scholarship from State University. The scholarship provided the following: Tuition and fees $15,000 Housing and meals 6,000 Books and supplies 1,500 Transportation 1,200 a. Determine the effect of the scholarship on Sally’s gross income. b. Sally’s brother, Willy, was not a gifted athlete, but he received $8,000 from their father’s employer as a scholarship during the year. The employer grants the children of all executives a scholarship equal to one-half of annual tuition, fees, books, and supplies. Willy also received a $6,000 scholarship (to be used for tuition) as the winner of an essay contest related to bioengineering, his intended field of study. Determine the effect of the scholarships on Willy’s and his father’s gross income.

35. LO.2 Adrian was awarded an academic scholarship to State University for the 2012– 2013 academic year. He received $6,000 in August and $7,000 in December 2012. Adrian had enough personal savings to pay all expenses as they came due. Adrian’s expenditures for the relevant period were as follows: Tuition, August 2012 $3,600 Tuition, January 2013 3,700 Room and board August–December 2012 3,000 January–May 2013 2,400 Books and educational supplies August–December 2012 1,100 January–May 2013 1,200 Determine the effect on Adrian’s gross income for 2012 and 2013.

36. LO.2 Leigh sued an overzealous bill collector and received the following settlement: Damage to her automobile that the collector attempted to repossess $ 3,300 Physical damage to her arm caused by the collector 15,000 Loss of income while her arm was healing 6,000 Punitive damages 80,000

a. What effect does the settlement have on Leigh’s gross income?

b. Assume that Leigh also collected $25,000 of damages for slander to her personal reputation caused by the bill collector misrepresenting the facts to Leigh’s employer and other creditors. Is this $25,000 included in Leigh’s gross income? Explain.

37. LO.2 Determine the effect on gross income in each of the following cases:

a. Eloise received $150,000 in settlement of a sex discrimination case against her former employer.

b. Nell received $10,000 for damages to her personal reputation. She also received $40,000 in punitive damages.

c. Orange Corporation, an accrual basis taxpayer, received $50,000 from a lawsuit filed against its auditor who overcharged for services rendered in a previous year.

d. Beth received $10,000 in compensatory damages and $30,000 in punitive damages in a lawsuit she filed against a tanning parlor for severe burns she received from using its tanning equipment.

e. Joanne received compensatory damages of $75,000 and punitive damages of $300,000 from a cosmetic surgeon who botched her nose job.

38. LO.2 Rex, age 55, is an officer of Blue Company, which provides him with the following nondiscriminatory fringe benefits in 2012: 

Hospitalization insurance premiums for Rex and his dependents. The cost of the coverage for Rex is $2,900 per year, and the additional cost for his dependents is $3,800 per year. The plan has a $2,000 deductible, but his employer contributed $1,500 to Rex’s Health Savings Account (HSA). Rex withdrew only $800 from the HSA, and the account earned $50 of interest during the year. 

Long-term care insurance premiums for Rex, at a cost of $12,600 per year. 

Insurance premiums of $840 for salary continuation payments. Under the plan, Rex will receive his regular salary in the event he is unable to work due to illness. Rex collected $4,500 on the policy to replace lost wages while he was ill during the year. 

Rex is a part-time student working on his bachelor’s degree in engineering. His employer reimbursed his $5,200 tuition under a plan available to all full-time employees. Determine the amount Rex must include in gross income.

39. LO.2 The UVW Union and HON Corporation are negotiating contract terms. Assume that the union members are in the 28% marginal tax bracket and that all benefits are provided on a nondiscriminatory basis. Write a letter to the UVW Union members explaining the tax consequences of the options discussed below. The union’s address is 905 Spruce Street, Washington, D.C. 20227.

a. The company would impose a $100 deductible on medical insurance benefits. Most employees incur more than $100 each year in medical expenses.

b. Employees would get an additional paid holiday with the same annual income (the same pay but less work).

c. An employee who did not need health insurance (because the employee’s spouse works and receives family coverage) would be allowed to receive the cash value of the coverage.

40. LO.2, 5 Mauve Corporation has a group hospitalization insurance plan that has a $200 deductible amount for hospital visits and a $15 deductible for doctor visits and prescriptions. The deductible portion paid by employees who have children has become substantial for some employees. The company is considering adopting a medical reimbursement plan or a flexible benefits plan to cover the deductible amounts. Either of these plans can be tailored to meet the needs of the employees. What are the cost considerations to the employer that should be considered in choosing between these plans?

41. LO.2 Belinda spent the last 60 days of 2012 in a nursing home. The cost of the services provided to her was $16,000. Medicare paid $8,500 toward the cost of her stay. Belinda also received $9,500 of benefits under a long-term care insurance policy she purchased. What is the effect on Belinda’s gross income?

42. LO.2 Tim is the vice president of western operations for Maroon Oil Company and is stationed in San Francisco. He is required to live in an employer-owned home, which is three blocks from his company office. The company-provided home is equipped with high-speed Internet access and several telephone lines. Tim receives telephone calls and e-mails that require immediate attention any time of day or night because the company’s business is spread all over the world. A full-time administrative assistant resides in the house to assist Tim with the urgent business matters. Tim often uses the home for entertaining ustomers, suppliers, and employees. The fair market value of comparable

housing is $9,000 per month. Tim is also provided with free parking at his company’s office. The value of the parking is $350 per month. Calculate the amount associated with the company-provided housing and free parking that Tim must include in his gross income.

43. LO.2 Does the taxpayer recognize gross income in the following situations?

a. Ava is a filing clerk at a large insurance company. She is permitted to leave the premises for her lunch, but she always eats in the company’s cafeteria because doing so is much less expensive than purchasing a comparable meal at a nearby restaurant. On average, she pays $3 for a lunch that would cost $8 at a restaurant. However, if the prices in the cafeteria were not so low and the food was not so delicious, she would probably bring her lunch at a cost of $2 per day.

b. Scott is a resident adviser (RA) in a college dormitory and is provided with lodging in the dormitory. He is not required to pay the $300 per month that a room costs other students. In addition, he is paid $100 per month. c. Ira recently moved to accept a job. For the first month on the new job, Ira was searching for a home to purchase or rent. During this time, his employer permitted Ira to live in an apartment the company maintains for customers during the buying season. The month that Ira occupied the apartment was not during the buying season, however, and the apartment would not otherwise have been occupied.

44. LO.2, 5 Bertha is considering taking an early retirement offered by her employer. She would receive $3,000 per month, indexed for inflation. However, she would no longer be able to use the company’s health facilities, and she would be required to pay her hospitalization insurance premiums of $8,000 each year. Bertha and her husband will file a joint return and take the standard deduction. She currently receives a salary of $55,000 a year. If she retires, she will spend approximately $300 less each month for commuting and clothing. Bertha and her husband have other sources of income and are in and will remain in the 25% marginal tax bracket. She currently pays Social Security and Medicare taxes of 5.65% on her salary, but her retirement pay would not be subject to this tax. According to Bertha, she and her husband could live well if her after-tax retirement income was at least 50% of her current income. Provide Bertha with information she will need to make her decision.

45. LO.2, 5 Finch Construction Company provides the carpenters it employs with all of the required tools. However, the company believes that this practice has led to some employees not taking care of the tools and to the mysterious disappearance of some tools. The company is considering requiring all of its employees to provide their own tools. Each employee’s salary would be increased by $1,500 to compensate for the additional cost. Write a letter to Finch’s management explaining the tax consequences of this plan to the carpenters. Finch’s address is 300 Harbor Drive, Vermillion, SD 57069.

46. LO.2, 5 Bluebird, Inc., does not provide its employees with any tax-exempt fringe benefits. The company is considering adopting a hospital and medical benefits insurance plan that will cost approximately $9,000 per employee. To adopt this plan, the company may have to reduce salaries and/or lower future salary increases. Bluebird is in the 35% (combined Federal and state rates) bracket. Bluebird is also responsible for matching the Social Security and Medicare taxes withheld on employees’ salaries (at the full 7.65% rate for 2012). The hospital and medical benefits insurance plan will not be subject to the Social Security and Medicare taxes, and the company is not eligible for the small business credit for health insurance. The employees generally fall into two marginal tax rate groups:

Income Tax Social Security and Medicare Tax Total .15 .0565 . 2065 .35 .0145 . 3645

The company has asked you to assist in its financial planning for the hospital and medical benefits insurance plan by computing the following:

a. How much taxable compensation is the equivalent of $9,000 of exempt compensation for each of the two classes of employees?

b. What is the company’s after-tax cost of the taxable compensation computed in part (a)?

c. What is the company’s after-tax cost of the exempt compensation?

d. Briefly explain your conclusions from the preceding analysis.

47. LO.2, 5 Rosa’s employer has instituted a flexible benefits program. Rosa will use the plan to pay for her daughter’s dental expenses and other medical expenses that are not covered by health insurance. Rosa is in the 25% marginal tax bracket and estimates that the medical and dental expenses not covered by health insurance will be within the range of $3,000 to $5,000. Her employer’s plan permits her to set aside as much as $5,000 in the flexible benefits account. Rosa does not itemize her deductions.

a. Rosa puts $3,000 into her flexible benefits account, and her actual expenses are $5,000. What is her cost of underestimating the expenses?

b. Rosa puts $5,000 into her flexible benefits account, and her actual expenses are only $3,000. What is her cost of overestimating her expenses?

c. What is Rosa’s cost of underfunding as compared to the cost of overfunding the flexible benefits account?

d. Does your answer in part (c) suggest that Rosa should fund the account closer to the low end or to the high end of her estimates?

48. LO.2 Sparrow Corporation would like you to review its employee fringe benefits program with regard to the tax consequences of the plan for the company’s president (Polly), who is also the majority shareholder.

a. The company has a qualified retirement plan. The company pays the cost of employees attending a retirement planning seminar. The employee must be within 10 years of retirement, and the cost of the seminar is $1,500 per attendee.

b. The company owns a parking garage that is used by customers, employees, and the general public. Only the general public is required to pay for parking. The charge to the general public for Polly’s parking for the year would have been $3,000 (a $250 monthly rate).

c. All employees are allowed to use the company’s fixed charge long-distance telephone services, as long as the privilege is not abused. Although no one has kept track of the actual calls, Polly’s use of the telephone had a value (what she would have paid on her personal telephone) of approximately $600.

d. The company owns a condominium at the beach, which it uses to entertain customers. Employees are allowed to use the facility without charge when the company has no scheduled events. Polly used the facility 10 days during the year. Her use had a rental value of $1,000.

e. The company is in the household moving business. Employees are allowed to ship goods without charge whenever there is excess space on a truck. Polly purchased a dining room suite for her daughter. Company trucks delivered the furniture to the daughter. Normal freight charges would have been $750.

f. The company has a storage facility for household goods. Officers are allowed a 20% discount on charges for storing their goods. All other employees are allowed a 10% discount. Polly’s discounts for the year totaled $900.

49. LO.2 George is a U.S. citizen who is employed by Hawk Enterprises, a global company. Beginning on June 1, 2012, George began working in London. He worked there until January 31, 2013, when he transferred to Paris. He worked in Paris the remainder of 2013. His salary for the first five months of 2012 was $100,000, and it was earned in the United States. His salary for the remainder of 2012 was $175,000, and it was earned in London. George’s 2013 salary from Hawk was $300,000, with part being earned in London and part being earned in Paris. What is George’s gross income in 2012 and 2013? (Assume that the 2013 indexed amount is the same as the 2012 indexed amount.)

50. LO.2, 3 Determine Hazel’s gross income from the following receipts for the year:

Gain on sale of Augusta County bonds $800

Interest on U.S. government savings bonds 400

Interest on state income tax refund 200

Interest on Augusta County bonds 700

Patronage dividend from Potato Growers Cooperative 350

The patronage dividend was received in March of the current year for amounts paid for her garden and lawn supplies.

 51. LO.2 In January 2012, Ezra purchased 2,000 shares of Gold Utility Mutual Fund for $20,000. In June, Ezra received an additional 100 shares as a dividend, in lieu of receiving $1,000 in cash dividends. In December, the company declared a two-for-one stock split. Ezra received an additional 2,100 shares, but there was no option to receive cash. At the time of the stock dividend in December and at the end of the year, the fund shares were trading for $11 per share. Also, at the end of the year, the fund offered to buy outstanding shares for $9. Ezra did not sell any shares during the year. a. What is Ezra’s gross income from the 100 shares received in June? b. What is Ezra’s gross income from the receipt of the 2,100 shares as a two-for-one stock split in December? c. Should Ezra be required to recognize gross income in 2012 even though the fair market value of his investment at the end of the year was less than the fair market value at the beginning of the year? Explain.

52. LO.2 Tonya, who lives in Virginia, inherited a $10,000 State of Virginia bond in 2012. Her marginal Federal tax rate is 35%, and her marginal state tax rate is 5%. The Virginia bond pays 4% interest, which is not subject to Virginia income tax. She can purchase a corporate bond of comparable risk that will yield 6% or a U.S. government bond that pays 5.6% interest. Tonya does not itemize her deductions. Which investment will provide the greatest after-tax yield?

53. LO.2 Lynn Swartz’s husband died three years ago. Her parents have an income of over $200,000 a year and want to ensure that funds will be available for the education of Lynn’s 8-year-old son Eric. Lynn is currently earning $45,000 a year. Lynn’s parents have suggested that they start a savings account for Eric. They have calculated that if they invest $4,000 a year for the next 8 years, at the end of 10 years, sufficient funds will be available for Eric’s college expenses. Lynn realizes that the tax treatment of the investments could significantly affect the amount of funds available for Eric’s education. She asked you to write a letter to her advising about options available to her parents and to her for Eric’s college education. Lynn’s address is 100 Myrtle Cove, Fairfield, CT 06824.

54. LO.2 Starting in 2002, Chuck and Luane have been purchasing Series EE bonds in their name to use for the higher education of their daughter Susie, who currently is age

18. During the year, they cash in $12,000 of the bonds to use for freshman year tuition, fees, and room and board. Of this amount, $5,000 represents interest. Of the $12,000, $8,000 is used for tuition and fees, and $4,000 is used for room and board. Chuck and Luane’s AGI, before the educational savings bond exclusion, is $112,000.

a. Determine the tax consequences for Chuck and Luane, who will file a joint return, and for Susie.

b. Assume that Chuck and Luane purchased the bonds in Susie’s name. Determine the tax consequences for Chuck and Luane and for Susie.

c. How would your answer to (a) change if Chuck and Luane file separate returns?

55. LO.2 Albert established a qualified tuition program for each of his twins, Kim and Jim. He started each fund with $20,000 when the children were five years old. Albert made no further contributions to his children’s plans. Thirteen years later, both children have graduated from high school. Kim’s fund has accumulated to $45,000, while Jim’s has accumulated to $42,000. Kim decides to attend a state university, which will cost $60,000 for four years (tuition, fees, room and board, and books). Jim decides to go to work instead of going to college. During the current year, $7,500 is used from Kim’s plan to pay the cost of her first semester in college. Because Jim is not going to go to college now or in the future, Albert withdraws the $42,000 plan balance and gives it to Jim to start his new life after high school.

a. During the period since the plans were established, should Albert or the twins have been including the annual plan earnings in gross income? Explain.

b. What are the tax consequences to Kim and Albert of the $7,500 being used for the first semester’s higher education costs?

c. Because of her participation in the qualified tuition program, Kim received a 10% reduction in tuition charges, so less than $7,500 was withdrawn from her account. Is either Albert or Kim required to include the value of this discount in gross income? Explain.

d. What are the tax consequences to Albert and Jim of Jim’s qualified tuition program being closed?

56. LO.3 How does the tax benefit rule apply in the following cases?

a. In 2010, the Orange Furniture Store, an accrual method taxpayer, sold furniture on credit for $1,000 to Sammy. The cost of the furniture was $600. In 2011, Orange took a bad debt deduction for the $1,000. In 2012, Sammy inherited some money and paid Orange the $1,000 he owed. Orange was in the 35% marginal tax bracket in 2010, the 15% marginal tax bracket in 2011, and the 35% marginal tax bracket in 2012.

b. In 2011, Marvin, a cash basis taxpayer, took a $2,000 itemized deduction for state income taxes paid. This increased his itemized deductions to a total that was $800 more than the standard deduction. In 2012, Marvin received a $1,600 refund when he filed his 2011 state income tax return. Marvin was in the 15% marginal tax bracket in 2011, but was in the 35% marginal tax bracket in 2012.

c. In 2011, Barb, a cash basis taxpayer, was in an accident and incurred $8,000 in medical expenses, which she claimed as an itemized deduction for medical expenses. Because of the 7.5%-of-AGI reduction, the expense reduced her taxable income by only $3,000. In 2012, Barb successfully sued the person who caused the physical injury and collected $8,000 to reimburse her for the cost of her medical expenses. Barb was in the 15% marginal tax bracket in both 2011 and 2012.

57. LO.4, 5 Fran, who is in the 35% tax bracket, recently collected $100,000 on a life insurance policy she carried on her father. She currently owes $120,000 on her personal residence and $120,000 on business property. National Bank holds the mortgage on both pieces of property and has agreed to accept $100,000 in complete satisfaction of either mortgage. The interest rate on the mortgages is 8%, and both mortgages are payable over 10 years. What would be the tax consequences of each of the following alternatives assuming that Fran currently deducts the mortgage interest on her tax return?

a. Retire the mortgage on the residence.

b. Retire the mortgage on the business property. Which alternative should Fran select?

58. LO.4 Vic, who was experiencing financial difficulties, was able to adjust his debts as follows:

a. His father agreed to cancel a $25,000 debt. Vic’s father told him, “I am not going to treat you any better than I treat your brothers and sisters; therefore, the $25,000 is coming out of your inheritance from me.”

b. The Land Company, which had sold land to Vic for $80,000, reduced the mortgage on the land by $12,000.

c. The Subprime Bank reduced the principal of the mortgage on Vic’s principal residence by $9,000.

Determine the tax consequences to Vic.


59. Alfred E. Old and Beulah A. Crane, each age 42, married on September 7, 2010. Alfred and Beulah will file a joint return for 2011. Alfred’s Social Security number is 111–11– 1111. Beulah’s Social Security number is 123–45–6789, and she adopted “Old” as her married name. They live at 211 Brickstone Drive, Atlanta, GA 30304.

Alfred was divorced from Sarah Old in March 2009. Under the divorce agreement, Alfred is to pay Sarah $1,250 per month for the next 10 years or until Sarah’s death, whichever occurs first. Alfred pays Sarah $15,000 in 2011. In addition, in January 2011, Alfred pays Sarah $50,000, which is designated as being for her share of the marital property. Also, Alfred is responsible for all prior years’ income taxes. Sarah’s Social Security number is 123–45–6788.

Alfred’s salary for 2011 is $150,000, and his employer, Cherry, Inc. (Federal I.D. No. 98–7654321), provides him with group term life insurance equal to twice his annual salary. His employer withheld $24,900 for Federal income taxes and $8,000 for state income taxes. The following amounts were withheld for FICA taxes: $4,486 ($106,800 × 4.2%) for Social Security and $2,175 ($150,000 × 1.45%) for Medicare. Beulah recently graduated from law school and is employed by Legal Aid Society, Inc. (Federal I.D. No. 11–1111111), as a public defender. She receives a salary of $40,000 in 2011. Her employer withheld $7,500 for Federal income taxes and $2,400 for state income taxes. The following amounts were withheld for FICA taxes: $1,680 ($40,000 × 4.2%) for Social Security and $580 ($40,000 × 1.45%) for Medicare. Beulah has $2,500 in qualified dividends on Yellow Corporation stock she inherited. Alfred and Beulah receive a $1,900 refund on their 2010 state income taxes. They itemized deductions on their 2010 Federal income tax return (total = $15,000). Alfred and Beulah pay $4,500 interest and $1,450 property taxes on their personal residence in 2011. Their charitable contributions total $2,400 (all to their church). They paid sales taxes of $1,400 for which they maintain the receipts. Compute the Olds’ net tax payable (or refund due) for 2011. If you use tax forms for your solution, you will need Form 1040 and Schedules A and B. Suggested software: H&R BLOCK At Home.

60. Martin S. Albert (Social Security number 111–11–1111) is 39 years old and is married to Michele R. Albert (Social Security number 123–45–6789). The Alberts live at 512 Ferry Road, Newport News, VA 23601. They file a joint return and have two dependent children, Charlene, age 17, and Jordan, age 18. Charlene’s Social Security number is 123– 45–6788, and Jordan’s Social Security number is 123–45–6787. In 2012, Martin and Michele had the following transactions:

a. Martin received $115,000 in salary from Red Steel Corporation, where he is a construction engineer. Withholding for Federal income tax was $10,750. The amounts withheld for FICA tax were as follows: $4,624 ($110,100 × 4.2%) for Social Security and $1,668 ($115,000 × 1.45%) for Medicare. Martin worked in Mexico from January 1, 2011, until February 15, 2012. His $115,000 salary for 2012 includes $16,000 he earned for January and one-half of February 2012 while working in Mexico.

b. Martin and Michele received $800 in qualified dividends on Green, Inc. stock and $400 interest on Montgomery County (Virginia) school bonds.

c. Martin received $2,300 interest from a Bahamian bank account.

d. Michele received 50 shares of Applegate Corporation common stock as a stock dividend. The shares had a fair market value of $2,000 at the time Michele received them, and she did not have the option of receiving cash.

e. Martin and Michele received a $900 refund on their 2011 Virginia income taxes. Their itemized deductions in 2011 totaled $12,500.

f. Martin paid $6,000 alimony to his former wife, Rose T. Morgan (Social Security number 123–45–6786).

g. Martin and Michele kept the receipts for their sales taxes paid of $1,100.

h. Martin and Michele’s itemized deductions were as follows: 

State income tax paid and withheld totaled $5,100. 

Real estate taxes on their principal residence were $3,400. 

Mortgage interest on their principal residence was $2,500. 

Cash contributions to the church totaled $2,800.

Part 1—Tax Computation

Compute the Alberts’ net tax payable (or refund due) for 2012.

Part 2—Tax Planning

The Alberts are considering buying another house. Their house mortgage payments would increase by $500 (to $1,500) per month, which includes a $250 increase in interest and a $100 increase in property tax. The Alberts would like to know how much the mortgage payments would increase net of any change in their income tax. Write a letter to the Alberts that contains your advice.


Research Problem 1. Murray reported to the Environmental Protection Agency that his employer was illegally dumping chemicals into a river. His charges were true, and Murray’s employer was fined. In retaliation, Murray’s employer fired him and made deliberate efforts to prevent Murray from obtaining other employment. Murray sued the employer, claiming that his reputation had been damaged. Murray won his lawsuit and received an award for “damages to his personal and professional reputation and for his mental suffering.” Now he would like to know whether the award is taxable. He argues that he was awarded damages as a recovery of his human capital and that a recovery of capital is not income. Therefore, the Federal government does not have the power to tax the award. 

Research Problem 2. The employees of the city of Greenville must make mandatory contributions to the city’s postretirement health benefit plan. The employees’ contributions are placed in a trust and are used exclusively for the employees’ benefits. The employees believe that because they are required to make the contributions from their base salaries, the result should be the same as if the employer made the contribution and had reduced their salaries by the amount of the contributions. Therefore, the employees believe they should be permitted to exclude the payments from gross income. The employees have asked you to research the issue.

 Research Problem 3. Kristina will soon graduate from law school with more than $40,000 in student loans. She would like to work as a public defender, but the pay is not enough to allow her to meet her living expenses and repay the student loans. Her law school offers a debt forgiveness program” for graduates who enter public service, including working as a public defender. Under the program, the school will pay the student’s debt, but the graduate will owe an equal amount to the program. However, if the graduate remains in public service for at least four years, the debt is forgiven. Kristina would like to know the tax consequences if she decides to utilize this program.

 Research Problem 4. Aubrey Brown is a decorated veteran of the Vietnam War. As a result of his exposure to Agent Orange during the war, Aubrey developed lung cancer and is unable to work. He received $12,000 of Social Security disability payments in the current year. He reasons that the payments should be excluded from his gross income because the payments are compensation for the physical injury he suffered as a result of his service in the armed forces. Is Aubrey correct? Explain. Partial list of research aids: Rev.Rul. 77–318, 1977–2 C.B. 45. Reimels v. Comm., 2006–1 USTC ¶50,147, 97 AFTR 2d 2006–820, 436 F.3d 344 (CA–2, 2006). 

Research Problem 5. Your client works for a defense contractor and was assigned to work on a military base in Australia. As a condition of his employment, he was required to live in housing that was provided to military personnel. The housing provided was a condominium located in a civilian neighborhood that was 20 miles from the military base where he performed his services. The employer paid over $6,000 of rent while the employee was living there. Your client would like to know whether the value of the housing can be excluded from his gross income. He read an article that indicated that employees who are required to live in a “camp” in a foreign country can exclude the cost of the housing from gross income. What is the result of your research?

Note: Solutions to Research Problems can be prepared by using the Checkpoint®

Student Edition online research product, which is available to accompany this text. It is also possible to prepare solutions to the Research Problems by using tax research materials found in a standard tax library.

 Research Problem 6. Go to the IRS website and download instructions and Regulations relative to educational savings bonds and qualified tuition programs. In outline format, summarize one of the key provisions in these materials. 

Research Problem 7. Employers often use the Internet as a means of attracting applications from potential employees. Locate an Internet site offering employment opportunities, ideally one provided by a well-known corporation. How does the employer promote its fringe benefit and cafeteria plan packages? Compare and contrast several such sites.