South Western Federal Taxation 2014 Individual Income Taxes 37Th Edition Hoffman Test Bank Full Chapter PDF

South-Western Federal Taxation 2014
Individual Income Taxes 37th Edition

Hoffman Test Bank
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CHAPTER 5
GROSS INCOME: EXCLUSIONS
SOLUTIONS TO PROBLEM MATERIALS
Status: Q/P
Question/ Learning Present in Prior
Problem Objective Topic Edition Edition
1 LO 2 Inheritance and compensation New

2 LO 2 Income from gifts Unchanged 2
3 LO 1, 2 Gift versus gross income Unchanged 3
4 LO 2 Life insurance proceeds and “income in Unchanged 4
respect of a decedent”
5 LO 2 Gift versus compensation Unchanged 5
6 LO 2 Gift and effect of legal obligation New
7 LO 2 Life insurance: transfer for valuable Unchanged 7
consideration
5-1
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
5-2 2014 Individual Income Taxes/Solutions Manual
Status: Q/P
8 LO 2 Life insurance: cash surrender value and Unchanged 8

accelerated death benefits
9 LO 2 Scholarship and lodging Unchanged 9
10 LO 2 Damages Modified 10
11 LO 2 Damages Unchanged 11
12 LO 2 Loss of income insurance and workers’ Unchanged 12
compensation
13 LO 2 Flexible benefit account Unchanged 13
14 LO 2, 5 Salary decrease versus health insurance Modified 14
premiums
15 LO 2 Cafeteria plans versus flexible spending Unchanged 15
plans
16 LO 2 Fringe benefits: employee discounts Unchanged 16
17 LO 2, 5 Alternative compensation options Modified 17
18 LO 2, 5 Qualified transportation fringe Unchanged 18
19 LO 2 Employer provided facilities Unchanged 19
20 LO 2 Qualified retirement planning services Unchanged 20
21 LO 2 Foreign earned income exclusion Unchanged 21
22 LO 2, 5 Tax-exempt bonds New
23 LO 3 Tax benefit rule Unchanged 23
24 LO 2 Qualified state tuition program Unchanged 24
25 LO 3 Tax benefit rule versus subsequent income New
payments
26 LO 4 Income from discharge of indebtedness New
27 LO 4 Income from discharge of indebtedness Unchanged 27
Gross Income: Exclusions 5-3
Status: Q/P
*28 LO 2 Life insurance, inheritance, and gifts Unchanged 28

29 LO 2 Life insurance and accident benefits New
30 LO 2, 5 Accelerated death benefits Unchanged 30
31 LO 2 Gifts versus compensation; scholarships Unchanged 31
32 LO 2 Death benefits; income in respect of a New
decedent
33 LO 2 Life insurance: use of proceeds Unchanged 33
34 LO 2 Scholarship Unchanged 34
35 LO 2 Scholarship Modified 35
38 LO 2 Health insurance, medical reimbursement Unchanged 38
39 LO 2 Fringe benefits Modified 39
40 LO 2, 5 Medical reimbursement plan versus Unchanged 40
flexible benefits plan
41 LO 2 Long-term care insurance benefits Unchanged 41
42 LO 2 Meals and lodging Updated 42
43 LO 2 Meals and lodging Modified 43
*44 LO 2, 5 Accident and health plans, athletic Unchanged 44
facilities
45 LO 2, 5 Working condition fringe Unchanged 45
*46 LO 2, 5 Fringe benefits versus taxable Unchanged 46
compensation
47 LO 2, 5 Flexible benefits plan Modified 47
48 LO 2 Fringe benefits Updated 48
*49 LO 2 Foreign earned income Updated 49
50 LO 2, 3 Tax benefit rule, tax-exempt income Unchanged 50
51 LO 2 Unrealized gains and losses and stock Unchanged 51
dividends
*52 LO 2 Tax-exempt bonds versus taxable bonds Modified 52
53 LO 2 Tax-favored educational savings programs Updated 53
54 LO 2 Educational savings bond exclusion Modified 54
55 LO 2 Qualified state tuition program Unchanged 55
56 LO 3 Tax benefit rule Unchanged 56
57 LO 4, 5 Income from discharge of indebtedness Unchanged 57
58 LO 4 Income from discharge of indebtedness New
*59 Cumulative Unchanged 59
*60 Cumulative Modified 60
*The solution to this problem is available on a transparency master.
Status: Q/P
Research Present In Prior
Problem Topic Edition Edition
1 Damages Unchanged 1
2 Gross income Unchanged 2
3 Gross income New
Status: Q/P
Research Present In Prior
Problem Topic Edition Edition
4 Gross income Unchanged 4

5 Foreign housing exclusion Unchanged 5
6 Internet activity Unchanged 6
7 Internet activity Unchanged 7
CHECK FIGURES
28. $0 although IRS may challenge 43.b. Included $0 in gross income.

exclusion of $12,000. 43.c. Lodging excluded from gross income.
29.a. Include in gross income. 44. Decrease in disposable income
29.b. Include in gross income. $15,542.
29.c. $0. 46.a. $11,342; $14,162.
29.d. $3,500. 46.b. $7,936; $9,339.
30.a. $15,000 capital gain on stock sale; 46.c. $5,850; $5,850.
$0 gross income if “terminally ill” 47.a. $280.
on insurance policy. 47.b. $720.
30.b. $15,000 capital gain on stock sale; 47.d. Low end.
$20,000 ordinary income on life 48.a. Include $0.
insurance policy. 48.b. Exclusion allowed for $2,940; include
31.a. The salary of $50,000 is included in $60.
gross income. 48.c. Exclusion allowed.
31.b. $3,000 as compensation. 48.d. Exclusion allowed.
31.c. $10,000 as compensation. 48.e. Exclusion allowed.
31.d. $0. 48.f. No exclusion for Polly; plan is
31.e. $0. discriminatory.
32. Include $100,000 in gross income. 49.a. $217,777.
33.a. Ray has $0 gross income on the 49.b. $202,400.
receipt of the $800,000 life 50. $1,400.
insurance proceeds. 51.a. $1,000.
33.b. $16,000 of interest is included in 51.b. $0 gross income.
gross income. 51.c. No current deduction; $1,000 income
33.c. $0 gain. when sell shares.
34.a. Room and board of $6,000 are 52. Greater after-tax yield on Virginia
includible and transportation of bond.
$1,200. 54.a. Exclude $3,116.
34.b. Additional compensation to Willy’s 54.b. Include $5,000 for Susie.
father. 54.c. Include $5,000.
35. $4,050 is includible in 2014. 55.a. $0.
36.a. Leigh must include $80,000 in 55.b. $0.
gross income. 55.c. $0.
36.b. Yes, include $25,000 in gross 55.d. $22,000.
income. 56.a. $1,000.
37.a. $150,000. 56.b. $800.
37.b. $50,000. 56.c. $3,000.
37.c. $50,000. 57.a. Additional tax $7,000.
37.d. $30,000. 57.b. Fran can defer the tax.
37.e. $300,000. 58.a. $25,000 gross income.
38. $4,500 plus $11,290 included in 58.b. $20,000 loss.
gross income. 58.c. Reduce basis by $12,000.
41. Include $0 in gross income. 59. Refund due for 2012 $2,008.
43.a. Include $3 per meal in gross income. 60. Refund due for 2013 $47.
DISCUSSION QUESTIONS
1. The $10,000 that John received is compensation for services and, therefore, must be included
in his gross income. pp. 5-4 and 5-5
2. Leonard must include $2,500 in his gross income. Because $2,500 was received from his
employer, it cannot qualify as a nontaxable gift, and no other exclusion provision would apply.
However, the amount received from his fellow employees was made out of detached generosity
and therefore is a nontaxable gift. The amount Leonard spent to repair the damage is not
relevant to determining his gross income, although, the cost may be partially deductible as a
personal casualty loss. pp. 5-4 and 5-5
3. The $250,000 is not a gift because the brothers paid to receive a benefit, which Earl directed
to be paid to his beneficiary. As to the beneficiary, the payment appears to be an inheritance.
However, the payment was not an inheritance of Earl’s property that passed to the beneficiary
upon Earl’s death. Rather, the payment arose out of Earl’s pre-death contract. The last
remaining possible reason for exclusion treatment is as life insurance proceeds. Perhaps the
brothers’ arrangement could be treated as a life insurance contract since they pooled resources
to share risk. pp. 5-4 to 5-7
4. Janice is not required to include her accrued salary in her gross income. Rather, the accrued
salary is income in respect of Janice (the decedent) and is included in the gross income of the
beneficiary, Wayne. The employer is not taxed on the insurance proceeds paid to the
employer-beneficiary upon the death of the insured. p. 5-6
5. Dolly should include $92 in her gross income. Even if the funds were received as the result of
a mistake, she has the free and unrestricted use of the funds, with no apparent claims against
the funds. In addition, since she received the amount from a customer in her employment
capacity, it is unlikely that she received a $90 gift. pp. 5-4 and 5-5
6. Carey must include all of her tips in gross income. Although the customers have no legal
obligation to pay her, in fact the payments are made for her services the customer received.
Therefore, the payments are compensation for services. p. 5-5
7. Assuming that Lime had taxable income in 2012 of at least $5,000, it received a tax benefit
from writing off the receivable. So Lime would include $3,500 in gross income in 2013 under
the tax benefit rule. The insurance proceeds could not be excluded from gross income because
the insurance contract proceeds were in consideration of the loan and not payable merely as
the result of Wally’s death. pp. 5-6 to 5-9
8. Ed must include his realized gain of $26,000 ($50,000 cash surrender value – $24,000 adjusted
basis) in his gross income. However, Sarah can exclude from her gross income her realized
gain of $26,000 ($50,000 cash surrender value – $24,000 adjusted basis) because she has a
terminal illness (i.e., the accelerated death benefits exclusion). What the funds are used for is
not relevant in determining the effect on the taxpayer’s gross income. Tom can exclude the
life insurance proceeds because he was the beneficiary of the policy (i.e., paid to him as the
result of the death of the insured). pp. 5-6 to 5-8
9. Joe’s gross income is $1,500. The use of a room, which is valued at $2,200, is excluded from
gross income because it is mandatory lodging provided on the employer’s business premises
for the convenience of the employer. The scholarship of $12,000 used for tuition can also be
excluded from Joe’s gross income. pp. 5-9 to 5-11 and 5-16 to 5-18
10. No. Billy’s award of $150,000 can be excluded from gross income because it arose out of a
physical personal injury, even though $50,000 was to replace income he would have otherwise
earned and would have been subject to tax. The $15,000 he received from the income
replacement policy he purchased is excluded from Billy’s gross income as a recovery of his
cost of the policy (but is not taxable even though the total benefit received may exceed the
premiums paid). Amber is taxed on the $30,000 she received under the income replacement
insurance policy because the premiums were paid by her employer (and would not have been
included in her gross income). pp. 5-11 to 5-13
11. No. The $10 million amount that Wes received is included in his gross income. However, Sam
is required to include only the $4 million in punitive damages in his gross income. His
compensatory damages are excluded from his gross income, even though the amount replaces
a loss of income, because the amount was received as a result of physical personal injury. pp.
5-11 and 5-12
12. Holly can exclude the $12,000 of workers’ compensation benefits she received from her gross
income. Jill can exclude the $12,000 she received for lost income because it was received
from an insurance policy that she had purchased. p. 5-12 and Chapter 4
13. Not necessarily—she has until March 15, 2014 to spend the balance in her flexible spending
account as of the end of 2013 for covered services. p. 5-21
14. Both Casey and Jean will experience a decrease in income net of health insurance premiums.
It is merely a question of which is the “least bad” option. As will be seen, both fare better
under option (2) although Jean is much better off with that option.
Under option (1), Casey would be required to pay $8,000 in premiums each year. Assuming
he cannot deduct the insurance as a medical expense because of the adjusted gross income
floor, his cash flow after-tax and health insurance premiums will decrease by $8,000. Under
option (2), Casey’s cash flow after-tax and health insurance premiums would decrease by
$8,500 [(1 – .15) × $10,000]. Therefore, Casey would be better off with option (1).
Jean would fare much better under the second option. As in Casey’s case, with option (1) she
is $8,000 poorer than without any change. But under option (2), her after-tax cash flow
decreased would decrease by $6,500 [(1 – .35) × $10,000]. Therefore, Jean would be better off
with option (2).
p. 5-14
15. With a cafeteria plan, the employee receives a salary and is also provided by the employer with
a fixed amount that he or she can allocate among a range of possible nontaxable fringe benefits
and taxable benefits. With a flexible spending plan, a portion of the employee’s salary is set
aside for specific uses that would have been excludible from gross income had the employer
paid these expenses. The employee’s gross income is reduced by the amount that goes into the
flexible spending account and the withdrawals are excluded from gross income. However, any
unused funds are forfeited by the employee. pp. 5-20 and 5-21
16. The discount on the price of the automobile of $4,600 ($33,600 – $29,000) is a qualified
employee discount. The discount can be excluded from Ted’s gross income because the price
he paid was above the employer’s cost. However, Ted must include in gross income 80% of
the dealer preparation fee, a service, of $300, which is $240 ($300 × 80%). The maximum
qualified employee discount that can be excluded for a service is 20%. pp. 5-22 and 5-23
17. The additional before tax salary that is required to purchase the health insurance for $9,000,
when the marginal tax rate is 25%, is $12,000 [$9,000/(1 – .25)]. p. 5-14
18. a. Tom must include the $100 in gross income. Mason is allowed to exclude the $100 as
a qualified transportation fringe.
b. Tom paid $100 for transportation cost and was reimbursed for that amount. Therefore,
Tom’s before-tax cost was $0. However. Tom is required to include the $100 in gross
income and thus must pay an additional $28 ($100 × .28) tax on the reimbursement,
which is his after-tax cost of commuting.
Mason’s after-tax cost of commuting is $0 because he is reimbursed for the out-of-

pocket cost and is not required to include the reimbursement in income.
pp. 5-24 and 5-25
19. The issues all relate to whether the employees would realize gross income from the employer
providing the facilities. If the employee does have gross income, the next question is: does the
benefit qualify under one of the exclusions provided in the Code?
• Does the employee experience an economic benefit from using the facility?
• Does the walking trail qualify as an excludible ‘‘athletic facility”?
• Is the benefit de minimis?
• Is the benefit a no-additional-cost service?
pp. 5-19 to 5-26
20. The facility provides an opportunity to provide the employees with non-taxable income. The
child day care services and exercise facility provided to the employees are specifically
excluded from their gross income. The use of the facility for family events could be provided
in a manner that qualifies as a no-additional cost employee fringe. pp. 5-19 and 5-20
21. 28%. Without the foreign earned income exclusion, Brad’s taxable income would have been
$111,000 ($25,000 + $86,000). Therefore, the applicable rate would be that applied to income
from $86,000 to $111,000, which is 28% in 2013. pp. 5-26 to 5-28 and Example 35
22. The Virginia bond yields the greatest after-tax income.
Virginia North Carolina

Bond Bond
Before-tax interest (on $100,000) $4,500 $4,600
Virginia tax @ .05 –0– (230)
Federal tax benefit from Virginia tax @ .35 –0– 81
Federal tax –0– –0–
After-tax income $4,500 $4,451
p. 5-29 and Example 37

23. $6,000. The cost of the feed and fertilizer was deducted as an expense in 2012. Therefore, the
distribution allocable to the deduction, $6,000, is included in gross income under the tax benefit
rule. The $200 allocable to the household purchases were not deducted and therefore the
amount received is a reduction in the cost of those purchases, rather than a recovery of a prior
deduction. p. 5-33
24. a. Andrea must include $10,000 ($25,000 – $15,000) in her gross income (i.e., the fund
earnings).
b. Both Andrea and Joanna can exclude the $7,500 from their gross income because this
amount was used to pay for higher education expenses.
p. 5-33
25. Dolly is not required to recognize income from the receipt of the state income tax refund of
$2,200. The refund merely corrects for her overpayment and the original payment did not
affect her taxable income. On the other hand, Molly received a tax benefit in the form of a
deduction on her 2012 Federal income tax return. Therefore, the $600 refund is the recovery
of a tax benefit. Whether Dolly and Molly itemize deductions in the year of recovery (2013) is
not relevant to whether they realized gross income from the recovery of 2012 state income
taxes. p. 5-33
26. The adjustment to Harry’s obligation is considered a reduction in Harry’s basis in the
equipment and no income is recognized. Thus, Harry’s income is deferred (e.g., future
depreciation expense will be reduced). The adjustment to Larry’s debt increases his gross
income from the discharge of his debt. This amount must be included in his gross income
unless he is bankrupt or insolvent. pp. 5-34 to 5-36
27. Ralph needs to identify and resolve the following issues:
• Is the friend forgiving the debt as a gift to Ralph?
• Did the mortgage holder sell the property to Ralph?
• Is Ralph insolvent or undergoing bankruptcy proceedings?
• Is the debt secured by his personal residence?
• If Ralph must recognize income from the debt cancellation, does he have losses to offset?
• May Ralph reduce the basis of the asset rather than recognizing income?
pp. 5-34 and 5-35
PROBLEMS
28. The $10,000 received from the general public is an excludible gift. The $12,000 that Ed’s
widow received in her “time of need” may be excluded from gross income if the company has
a general policy of making such payments. Otherwise, the IRS may challenge the payment as
a taxable payment for Ed’s prior services. The $25,000 debt canceled by the hospital should
not increase gross income. This results because to the extent the debt cancellation is included
in gross income, Ed should be allowed a medical expense deduction that is subject to the
percentage of AGI non-deductible amount. The debt attributable to the non-deductible portion
should be excluded from gross income under the tax benefit rule, because the recovery of the
expense is excluded from gross income to the extent the expense did not yield a tax benefit.
The life insurance proceeds are excluded from gross income since they were paid to the
beneficiary of a life insurance policy. pp. 5-5 to 5-7 and Chapter 14
29. a. The payments received for not working must be included in Justin’s gross income
because he experienced an increase in wealth when the payment was received (although
he may experience a decrease in future income).
b. The payments received by Trina must be included in her gross income. The payments
were not gifts, although they were made because of her dire circumstances, because the
Internal Revenue Code specifically provides that employers cannot be considered
donors to their employees.
c. The life insurance proceeds are excluded from Coral Corporation’s gross income. The
corporation collected the proceeds as the beneficiary of the policy upon the death of
the insured.
d. The life insurance proceeds of $40,000 are excluded from Juan’s gross income. He
collected the proceeds as the beneficiary of the policy upon the death of the insured.
The fact that the corporation paid the premiums and the premiums were excluded from
Leona’s gross income does not affect the tax treatment of the proceeds. The accrued
salary must be included in Juan’s gross income because it would have been taxable to
Juan’s wife if she had collected it (“income in respect of a decedent”).
pp. 5-5 to 5-8
30. a. The sale of the stock by Laura will result in a $15,000 ($50,000 amount realized
– $35,000 adjusted basis) capital gain. However, Laura’s capital gain rate may be 0%
if she is in the 10% or 15% marginal tax brackets. If she is in the 25% or greater
marginal tax brackets, her alternative tax rate will be 15%. So her tax liability on the
$15,000 capital gain could be either $2,250 ($15,000 × 15%) or $0 ($15,000 × 0%). If
Laura is diagnosed as “terminally ill,” the realized gain on the life insurance policy of
$20,000 ($50,000 – $30,000) is excluded from her gross income.
b. Capital gain treatment would apply to the sale of the stock by Laura’s mother. The
$20,000 realized gain on the life insurance policy will be included in the gross income
of Laura’s mother. Laura’s mother cannot qualify for the exclusion because she is not
terminally ill. The mother’s recognized gain of $20,000 will not be eligible for capital
gain treatment because cashing in the life insurance policy is not considered a “sale or
exchange,” which is a requisite for capital gain treatment. Regardless of how the
medical bills are financed, Laura’s mother will be allowed to take an itemized
deduction for the medical expenses paid (less the AGI floor) for her dependent daughter
assuming she itemizes her deductions.
pp. 5-6 to 5-8
31. a. $50,000 salary.
b. $3,000, the value of the trip.
c. The $10,000 as compensation, unless this is paid under a non-discriminatory medical
reimbursement plan available to other employees.
d. The $15,000 is an excluded gift since it was paid based on Blake’s need.
e. Zero. Life insurance proceeds paid to the beneficiary upon death of the insured are
excluded from gross income.
pp. 5-6 and 5-7
32. Darlene’s gross income from the receipts is $100,000.

Amount Gross
Received Income
a. Employer payments, not excluded as gift $ 60,000 $60,000
b. Accrued salary, earned before death $ 20,000 $20,000
c. Group term life insurance proceeds $480,000 –0–
d. Life insurance proceeds, annuity $ 30,000 $30,000
Less: recovery of capital
($250,000/$750,000) × $30,000 ($10,000)
$100,000
pp. 5-6 to 5-9 and Chapter 4
33. a. Ray is the beneficiary of the life insurance policy and can exclude the proceeds of
$800,000 from his gross income.
b. The $16,000 of interest earned on the life insurance proceeds left with the insurance
company is included in Ray’s gross income.
c. Ray did not recognize a gain on the bargain purchase. Ray simply got a good price on
the purchase under an arm’s length contract.
pp. 5-7 and 5-10
34. a. The $16,500 received for tuition, fees, books, and supplies can be excluded from
Sally’s gross income as a scholarship. The $6,000 received for room and board and the
$1,200 received for transportation must be included in her gross income. The athletic
scholarship is considered a payment to further the recipient’s education and is not
compensation for services.
b. The $8,000 ‘‘scholarship’’ is additional compensation to Willy’s father. The fact that
the ‘‘scholarships’’ are only awarded to the children of executives indicates that the
employer is not simply making payments to assist the student seeking his or her
education, but rather to compensate an employee. However, the
$6,000 scholarship received as a contest winner is excluded from gross income.
Although contest winnings are generally subject to tax, the exception is if the prize is
a scholarship.
pp. 5-9 and 5-10
35. Adrian received a total of $13,700 and spent $9,650 ($3,700 + $3,750 + $1,000 + $1,200) on
tuition, books, and supplies. The amount received for room and board is not excludible from
gross income. Therefore, he must include $4,050 ($13,700 – $9,650) in gross income. When
he received the money in 2013, Adrian’s total expenses for the period covered by the
scholarship were not known. Therefore, he is allowed to defer reporting the income until 2014,
when all the uncertainty is resolved. pp. 5-9 and 5-10
36. a. Leigh must include in gross income the punitive damages of $80,000. The other
amounts ($15,000 and $6,000) may be excluded as arising out of the physical personal
injury, except the $3,300 amount received for damage to her automobile. This amount
is a nontaxable recovery of capital (i.e., it reduces her basis for the automobile by
$3,300).
b. The $25,000 is included in Leigh’s gross income because it did not arise out of
a physical personal injury.
pp. 5-11 and 5-12
37. a. The settlement in the sex discrimination case did not arise out of physical personal
injury or sickness. Therefore, the $150,000 is included in Eloise’s gross income.
b. The damages to Nell’s personal reputation are not for physical personal injury or
sickness. Therefore, Nell must include the $10,000 in her gross income. She must also
include the $40,000 punitive damages in her gross income.
c. The damages of $50,000 are included in Orange Corporation’s gross income under the
tax benefit rule, assuming the company received tax benefit from deducting the audit
fees in a previous year.
d. The compensatory damages of $10,000 for the physical personal injury are not included
in Beth’s gross income, but the punitive damages of $30,000 must be included in her
gross income.
e. Since the compensatory damages of $75,000 arose from a physical personal injury,
they are excluded from Joanne’s gross income. The punitive damages of $300,000 are
included in her gross income.
pp. 5-11 and 5-12

38. Rex is required to include in gross income the $4,500 received from the wage continuation
policy while he was ill. This amount is included in gross income only because the employer
paid for the policy. Rex also is required to include in gross income part of the long-term care
insurance premiums of $12,600 paid by his employer ($12,600 – $1,360 = $11,240). The other
items can be excluded from gross income. pp. 5-14 to 5-16
39. Hoffman and Smith, CPAs

5191 Natorp Boulevard
Mason, OH 45040
September 27, 2013
UVW Union
905 Spruce Street
Washington, D.C. 20227
Dear Union Members:
You asked me to explain the tax consequences of HON Corporation’s proposed changes in the
employees’ compensation package. The proposed changes include (1) the elimination of
the $250 deductible clause in the medical benefits plan, (2) an additional paid holiday, and (3)
a cafeteria plan that would allow the employee to receive cash rather than medical insurance.
The deductible clause will benefit each employee in the amount of $250 each year. That is, the
employee will have an additional $250 for the same medical benefits that the employee
presently receives and, generally, none of the $250 will be includible in arriving at taxable
income. The additional paid holiday will have no effect on after-tax income—the employee’s
annual gross income will not change. The cafeteria plan will mean that some employees who
now have excess medical coverage can substitute cash for the unneeded protection. The cash
received will be taxable, but the employee’s after-tax income will increase.
In summary, the change with the broadest tax implications is the elimination of the $250
deductible for medical benefits. The effect on the employee will be the same as a $333 raise
($250/.75).
Also, the cafeteria plan may be important for some employees, depending upon how many of
them have working spouses whose employers provided medical benefits for the employee’s
entire family.
Please contact me if you have any further questions.
Sincerely yours,
John J. Jones, CPA
Partner
pp. 5-14, 5-20, and 5-21
40. With a medical reimbursement plan, Mauve would be paying all of the employee’s medical
expenses. The employee would have no incentive to control costs. With the flexible benefit
plan, the employee must contribute to the costs through a salary reduction under the flexible
benefit plan. Therefore, for this plan the employee has an incentive to minimize costs. pp. 5-15,
5-20, and 5-21
41. Belinda must include $0 ($10,700 exclusion – $9,500 long-term care insurance payments
received) in her gross income for the long-term care insurance benefits she received. The
charges by the nursing home were less than the maximum exclusion ($320 per day). The
potential exclusion is the greater of the following:
• $320 indexed amount for each day the patient receives the long-term care ($19,200).
• The actual cost of the long-term care ($16,000).
Therefore, the amount excluded from her gross income is the statutory indexed amount of
$19,200 reduced by the Medicare payments. Thus, the exclusion is $10,700 ($19,200 –
$8,500). Because the long-term care insurance payments received of $9,500 are less than the
exclusion amount of $10,700, none of the payments received is included in gross income. p. 5-
16
42. The concern in this situation for Tim is that the house will not be considered ‘‘on the
employer’s premises’’ in order for Tim to qualify for the meal and lodging exclusion.
However, Tim could effectively argue that the house is an extension of the employer’s office
because of the extensive business activities (communications, entertaining) conducted in the
house. He should be prepared to document the extent of business activities conducted at the
house. The presence of an administrative assistant would suggest that much more than
incidental business activities are conducted in the home. Gross income would include $105
($350 – $245) per month because the benefit exceeds the qualified parking monthly exclusion
limit of $245. pp. 5-16 to 5-18 and 5-24
43. a. It appears that Ava’s meals are not provided for the convenience of the employer, but
rather as a convenience for the employee. Thus, this is a taxable fringe benefit.
Therefore, Ava is required to include in gross income the difference between the
amount she paid for the meals, $5, and the amount she would be required to pay of $8
to an unrelated restaurant. A comparison to the poorer quality of the self-prepared lunch

is not a valid measure of the benefit she actually received.
b. Scott is not required to include anything in gross income for the use of the
condominium. The lodging is for the convenience of the employer. Also, because of
the close proximity of the condominium to the office, the condominium is considered
to be on the employer’s business premises according to the Tax Court.
c. Apparently Ira is not being provided the housing for the convenience of his employer.
However, the use of the apartment should qualify as a no-additional-cost service
because the apartment would otherwise be vacant.
pp. 5-16 to 5-18 and 5-21
44. Only Bertha can decide whether she should take early retirement. As an aid in making her
decision, you can inform her that her disposable income after the effect of the revisions created
by retirement will decrease by approximately $14,400 a year, or by substantially less than 50%
of her current after-tax income.
Disposal
Now Retired Income
Salary/retirement $55,000 $36,000
Reduced commuting and clothing costs (3,600) (–0–)
Social Security and Medicare tax (4,208) (–0–)
Income tax (.25) (8,875) (4,125)
Medical insurance (–0–) (8,000)
$38,317 $23,875
Disposable income associated with employment $38,317

Less: Disposable income associated with retirement (23,875)
Decrease in disposable income $14,442
pp. 5-14 and 5-19

45. Hoffman and Smith, CPAs
5191 Natorp Boulevard
Mason, OH 45040
September 18, 2013
Finch Construction Company
300 Harbor Drive
Vermillion, SD 57069
Dear Management:
You asked me to determine the tax implications of requiring the company’s employees who
are carpenters to furnish their own tools, with a compensating increase in their salaries of about
$1,500 each. In short, most employees would experience a net decrease in after-tax income.
Under the company’s present way of doing business, the carpenters do not recognize income
when the employer provides tools. This is a ‘‘working condition fringe.’’ If the employee’s
salary is increased and he or she must purchase the necessary tools, the employee must include
the additional $1,500 in salary in gross income. But the cost of the tools in many cases will not
be deductible, or less than the actual cost will be deductible. This results from the employee’s
expense being a deduction from adjusted gross income as a miscellaneous itemized deduction.
If the employee takes the standard deduction, no deduction for the tool expenses is allowed. If
the taxpayer does itemize deductions, the total miscellaneous itemized deductions must be
reduced by 2% of the employee’s adjusted gross income. In many cases, the total
miscellaneous itemized deductions will be less than 2% of AGI. When the total miscellaneous
itemized deductions do exceed 2% of AGI, less than the entire expenses are deductible because
of the 2% factor.
Another possibility would be for the employees to purchase the tools, but account to you for
their cost, and obtain reimbursement. Under this plan, the employee would be allowed to
directly offset the reimbursement with the expense, in arriving at adjusted gross income. The
request for reimbursement would also provide you with a means of controlling costs.
Please contact me if you would like to discuss this further.
Sincerely,
Amy Evans, CPA
Partner
pp. 5-23 and 5-24
46. a. Low High

Benefits $9,000 $ 9,000
Income tax rate 0.15 0.35
Social Security and Medicare tax rate 0.0765 0.0145
Total marginal tax rate (MTR) 0.2265 0.3645
1 – MTR .7735 .6355
Before tax compensation =
[$9,000 ÷ (1 – MTR)] $11,635 $14,162
b. Before tax compensation $11,635 $14,162
Employer’s Social Security tax rate 0.0765 0.0145
Employer’s Social Security tax 890 205
Total before income tax cost to employer $12,525 $14,367
Less: employer’s tax benefit (@ .35) (4,384) (5,028)
Employer’s after-tax cost of taxable
compensation $ 8,141 $ 9,339
c. Exempt compensation to employees $ 9,000 $ 9,000
Less: employer’s tax benefit (@ .35) (3,150) (3,150)
Employer’s after-tax cost of exempt benefit $ 5,850 $ 5,850
d. For an after-tax cost of $5,850 per employee, Bluebird can provide tax-exempt benefits
to its employees that are equivalent to before-tax taxable compensation of $11,635 and
$14,162, respectively, depending on the employee’s marginal tax bracket. It would cost
the company $8,141 and $9,339, respectively, to provide the taxable compensation
equivalent of $9,000 tax-exempt income. Both the employer and the employee benefit
from the exemption. Note, however, that if an employee is already covered in a similar
medical benefit plan under a spouse’s plan, the employee may want the cash
compensation instead.
p. 5-14
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Sea Hound attacked. By Columbia Pictures Corporation. (The Sea
Industries, Inc. (PWH); 23Dec74; R593907.
R593908.
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The Law comes to Gunsight. By Monogram Pictures Corporation.
6 reels. © 22May47; L1044. Allied Artists Pictures Corporation
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R594066.
Sarge goes to college. By Monogram Pictures Corporation. 7 reels.
© 23May47; L1082. Allied Artists Pictures Corporation formerly
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R594066.
R594147.
R594148.
R594148.
R594149.
R594149.
R594212.
Tenth Avenue angel. By Loew’s, Inc. 74 min. © 23Dec47; L1395.
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If winter comes. By Loew’s, Inc. 97 min. © 23Dec47; L1398.
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Bowling tricks. By Loew’s, Inc. 10 min. © 23Dec47; M2603.
‫ ٭‬U. S. GOVERNMENT PRINTING OFFICE: 1975 O-588-418

These entries alone may not reflect the complete Copyright Office
record pertaining to a particular work. Contact the U.S. Copyright
Office for information about any additional records that may exist.
Copyright Changed From Changed To
Registration
or Page
Number
MP25712 Clever Hikcichi Clever Hikoichi
MP25719 Southern California Southern
California California
Permanente Permanente
Medical Group Medical Group
MP26079 Stan Brakhage Stan Brakhage
R567077 Terry Toons Terry-Toons
TRANSCRIBER’S NOTES
1. Corrected spelling, accents, grammar, hyphenation, and
punctuation of names according to the following
guidelines.
The names of movies in the main Motion
Pictures list determined usage unless all the
Index entries indicate otherwise. See change
list.
The names of individuals and companies
featured in the Index listing determined usage
unless all of the Motion Pictures entries
indicated otherwise. See change list.
2. Silently corrected simple spelling, grammar, and
typographical errors of other than names of movies,
persons, and companies as mentioned previously.
3. Otherwise retained anachronistic and non-standard
spellings as printed.

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GROSS INCOME: EXCLUSIONS

SOLUTIONS TO PROBLEM MATERIALS

1 LO 2 Inheritance and compensation New

8 LO 2 Life insurance: cash surrender value and Unchanged 8

*28 LO 2 Life insurance, inheritance, and gifts Unchanged 28

*The solution to this problem is available on a transparency master.

4 Gross income Unchanged 4

28. $0 although IRS may challenge 43.b. Included $0 in gross income.

Mason’s after-tax cost of commuting is $0 because he is reimbursed for the out-of-

pp. 5-24 and 5-25

• Does the walking trail qualify as an excludible ‘‘athletic facility”?

• Is the benefit de minimis?

• Is the benefit a no-additional-cost service?

pp. 5-19 to 5-26

Virginia North Carolina

p. 5-29 and Example 37

• Is the friend forgiving the debt as a gift to Ralph?

• Did the mortgage holder sell the property to Ralph?

• Is Ralph insolvent or undergoing bankruptcy proceedings?

• Is the debt secured by his personal residence?

32. Darlene’s gross income from the receipts is $100,000.

pp. 5-11 and 5-12

39. Hoffman and Smith, CPAs

• The actual cost of the long-term care ($16,000).

to an unrelated restaurant. A comparison to the poorer quality of the self-prepared lunch

Disposable income associated with employment $38,317

pp. 5-14 and 5-19

pp. 5-23 and 5-24

46. a. Low High

‫ ٭‬U. S. GOVERNMENT PRINTING OFFICE: 1975 O-588-418

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