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Practice Test-Chapter 4

Indicate whether the statement is true or false.


1. Barney painted his house which saved him $3,000. According to the realization requirement, Barney must recognize
$3,000 of income.
a.
True
b.
False
2. The fact that the accounting method the taxpayer uses to measure income is consistent with GAAP does not assure that
the method will be acceptable for tax purposes.
a.
True
b.
False
3. At the beginning of 2015, Mary purchased a 3-year certificate of deposit (CD) for $8,760. The maturity value of the
certificate was $10,000 and it was to yield 4.5%. She also purchased a Series EE bond for $6,400 with a maturity value in
10 years of $10,000. Mary must recognize $1,240 of income from the certificate of deposit in 2015, and $3,600 from the
Series EE bonds in 2024.
a.
True
b.
False
4. The constructive receipt doctrine requires that income must be recognized when it is made available to the cash basis
taxpayer, although it has not been actually received. The constructive receipt doctrine does not apply to accrual basis
taxpayers.
a.
True
b.
False
5. Jessica is a cash basis taxpayer. When Jessica failed to repay a loan, the bank garnished her salary. Each week $60 was
withheld from Jessicas salary and paid to the bank. Jessica is required to include the $60 each week in her gross income
even though it is the creditor that benefits from the income.
a.
True
b.
False

Indicate the answer choice that best completes the statement or answers the question.
6. The annual increase in the cash surrender value of a life insurance policy:
a. Is taxed when the individual dies and the heirs collect the insurance proceeds.
b. Must be included in gross income each year under the original issue discount rules.
c. Reduces the deduction for life insurance expense.
d. Is not included in gross income each year because of the substantial restrictions on gaining access to the
policys value.
e. None of these.
7. Turner, a successful executive, is negotiating a compensation plan with his potential employer. The employer has
offered to pay Turner a $600,000 annual salary, payable at the rate of $50,000 per month. Turner counteroffers to receive a
monthly salary of $40,000 ($480,000 annually) and a $180,000 bonus in 5 years when Turner will be age 65.
a. If the employer accepts Turners counteroffer, Turner will recognize $660,000 at the time the offer is accepted.
b. If the employer accepts Turners counteroffer, Turner will recognize as gross income $55,000 per month
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Practice Test-Chapter 4
[($480,000 + $180,000)/12].
c. If the employer accepts Turners counteroffer, Turner will recognize $40,000 income each month for the
year and $180,000 in year 5.
d. If the employer accepts Turners counteroffer, Turner must recognize imputed interest income on the $180,000
to be received in 5 years.
e. None of these.
8. Teal company is an accrual basis taxpayer. On December 1, 2015, a customer paid for an item that was on hand, but the
customer wanted the item delivered in early January 2016. Teal delivered the item on January 4, 2016. Teal included the
sale in its 2015 income for financial accounting purposes.
a. Teal must recognize the income in 2015.
b. Teal must recognize the income in the year title to the goods passed to the customer, as determined under the
state laws in which the store is located.
c. Teal can elect to recognize the income in either 2015 or 2016.
d. Teal must recognize the income in 2016.
e. None of these.
9. Under the alimony rules:
a. To determine whether a cash payment is alimony, one must consult the state laws that define alimony.
b. A person who receives a property division has experienced an increase in wealth and thus should be subject to
tax.
c. The income is included in the gross income of the recipient of the payments.
d. A person who earns $90,000 and pays $20,000 in alimony is taxed on $90,000 because the $20,000 alimony is
income assigned to the former spouse.
e. None of these.
10. Under the terms of a divorce agreement, Kim was to pay her husband Tom $7,000 per month in alimony. Kims
payments will be reduced to $3,000 per month when their 9 year-old son becomes 21. The husband has custody of their
son. For a twelve-month period, Kim can deduct from gross income (and Tom must include in gross income):
a.
$60,000.
b.
$48,000.
c.
$36,000.
d.
$0.
e.
None of these.
11. Betty purchased an annuity for $24,000 in 2015. Under the contract, Betty will receive $300 each month for the rest of
her life. According to the actuarial estimates, Betty will live to receive 96 payments and will receive a 3% return on her
original investment.
a. If Betty collects $3,000 in 2015, her gross income is $630 (.03 $21,000).
b. Betty has no gross income until she has collected $24,000.
c. If Betty lives to collect more than 96 payments, all of the amounts collected after the 96th payment must
be included in taxable income.
d. If Betty lives to collect only 60 payments before her death, she will report a $6,000 loss from the annuity
[$24,000 (60 $300) = $6,000] on her final return.
e. None of these.
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Practice Test-Chapter 4
12. The amount of Social Security benefits received by an individual that he or she must include in gross income:
a. Is computed in the same manner as an annuity [exclusion = (cost/expected return) amount received].
b. May not exceed the portion contributed by the employer.
c. May not exceed 50% of the Social Security benefits received.
d. May be zero or as much as 85% of the Social Security benefits received, depending upon the taxpayers
Social Security benefits and other income.
e. None of these.
13. Our tax laws encourage taxpayers to ____ assets that have appreciated in value and ____ assets that have declined in
value.
a.
sell; keep.
b.
sell; sell.
c.
keep; sell.
d.
keep; keep.
e.
None of these.
14. The purpose of the tax rules that apply to below-market loans between family members is to:
a. Discourage loans between related parties.
b. Prevent shifting of income among family members.
c. Prevent gifts from being disguised as bad debt expenses.
d. Prevent gift tax avoidance.
e. None of these is true.
15. Wayne owns a 30% interest in the capital and profits of Emerald Company (a calendar year partnership). For tax year
2014, the partnership earned revenue of $900,000 and had operating expenses of $660,000. During the year, Wayne
withdrew from the partnership a total of $90,000. He also invested an additional $30,000 in the partnership. For 2014,
Waynes gross income from the partnership is:
a.
$72,000.
b.
$90,000.
c.
$132,000.
d.
$162,000.
e.
None of these.
16. Darryl, a cash basis taxpayer, gave 1,000 shares of Copper Company common stock to his daughter on September 29,
2015. Copper Company is a publicly held company that has declared a $2.00 per share dividend on September 30th every
year for the last 20 years. Just as Darryl had expected, Copper Company declared a $2.00 per share dividend on
September 30th, payable on October 15th, to stockholders of record as of October 10th. The daughter received the $2,000
dividend on October 18, 2015.
a. The daughter must recognize the income because she owned the stock when the dividend was declared
and she received the $2,000.
b. Darryl must recognize the income of $2,000 because the purpose of the gift was to avoid taxes.
c. Darryl must recognize $1,500 of the dividend because he owned the stock for three-fourths of the year.
d. Darryl must recognize the $2,000 dividend as his income because he constructively received the dividend.
e. None of these.
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Practice Test-Chapter 4
17. As a general rule:
I.
Income from property is taxed to the person who owns the property.
II.
Income from services is taxed to the person who earns the income.
III.
The assignee of income from property must pay tax on the income.
IV.
The person who receives the benefit of the income must pay the tax on the income.
a.
Only I and II are true.
b.
Only III and IV are true.
c.
I, II, and III are true, but IV is false.
d.
I, II, III, and IV are true.
e.
None of these is true.
18. With respect to the prepaid income from services, which of the following is true?
a. The treatment of prepaid income is the same for tax and financial accounting.
b. A cash basis taxpayer can spread the income over the period services are to be provided if all of the services
will be completed by the end of the tax year following the year of receipt.
c. An accrual basis taxpayer can spread the income over the period services are to be provided if all of the
services will be completed by the end of the tax year following the year of receipt.
d. An accrual basis taxpayer can spread the income over the period services are to be provided on a contract for
three years or less.
e. None of these.
19. Under the original issue discount (OID) rules as applied to a three-year certificate of deposit:
a. All of the income must be recognized in the year of maturity by a cash basis taxpayer.
b. The OID will be included in gross income for the year of purchase.
c. The interest income will be the same each year.
d. The interest income will be greater in the third year than in the first year.
e. None of these is correct.
20. Maroon Corporation expects the employees income tax rates to increase next year. The employees use the cash
method. The company presently pays on the last day of each month. The company is considering changing its policy so
that the December salaries will be paid on the first day of the following year. What would be the effect on an employee of
the proposed change in company policy for paying its salaries beginning December 2015?
a. The employee would be required to recognize the income in December 2015 because it is constructively
received at the end of the month.
b. The employee would be required to recognize the income in December 2015 because the employee has a claim
of right to the income when it is earned.
c. The employee will not be required to recognize the income until it is received, in 2016.
d. The employee can elect to either include the pay in 2015 or 2016.
e. None of these.

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Practice Test-Chapter 4
Answer Key
1. False
2. True
3. False
4. True
5. True
6. d
7. c
8. a
9. c
10. c
11. c
12. d
13. c
14. b
15. a
16. a
17. a
18. c
19. d
20. c

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