Question 1

Connie was walking her dog when she came across a paper bag with $20,000 in it. She turned the money into the police. After the appropriate period of time, no one claimed the money and the police returned the money to Connie. Connie does not have to recognize any taxable income since it was not derived from capital or labor.

Accepted Answer

Found property that is not returned to its rightful owner is considered taxable income by the IRS, regardless of how it was obtained.

Question 2

The hybrid method of accounting provides that taxpayers will account for sales of merchandise and the related cost of goods sold on the accrual basis and all other items of income and expense on the cash basis.

Accepted Answer

The statement accurately describes the hybrid method of accounting.

Question 3

Income realization may occur as a result of I. Relief from a liability. II. Exchange of property. III. Payment of the taxpayer's indebtedness by another. IV. A barter transaction where only goods and services are exchanged.

Accepted Answer

Income realization can occur through various means, including relief from a liability (where the reduction in debt can be considered income), exchange of property (where the gain from the exchange can be considered income), payment of the taxpayer's indebtedness by another (which can result in income to the taxpayer), and barter transactions (where the value of goods or services received can be considered income).

Question 4

Terry owns 100% of Terry Manufacturing, Inc, and has the corporation pay his son's college tuition. Terry must include the payments in his taxable income.

Accepted Answer

Since Terry owns 100% of the corporation, any payments made by the corporation on his behalf or his family's behalf are considered taxable income for Terry.

Question 5

Ruth purchased an annuity contract for $10,000. When she turns 65, she will receive $150 a month for the rest of her life. The first $10,000 she receives is a return of her capital and is not taxable.

Accepted Answer

The $10,000 Ruth initially paid for the annuity contract is not taxable, but the $150 monthly payments she will receive when she turns 65 will be taxable as income.

Question 6

Mercedes has a net long-term capital gain of $3,000 and a net short-term capital loss of $10,000. She can deduct $3,000 of the $7,000 net loss as a deduction for adjusted gross income in the current year. She must defer realizing any tax benefit from the remaining $4,000 loss until the next year.

Accepted Answer

This is correct. The $3,000 net long-term capital gain can offset $3,000 of the net short-term capital loss, leaving a remaining $7,000 loss. Mercedes can deduct $3,000 of this as a deduction for adjusted gross income in the current year, but the remaining $4,000 loss must be carried over to the next tax year.

Question 7

Which of the following constitutes a realization? I. Frank's lakeside cottage is damaged in a violent storm. The cost of repairs totaled $4,000. However, the insurance company gives Frank only $2,500 for the repairs. II. McDonald's cow gives birth. The calf will become a member of McDonald's feeder cattle herd.

Accepted Answer

Only statement I constitutes a realization, as it describes a situation where something unexpected happens and has a real impact on someone's situation. Statement II describes a routine event in the business operations of McDonald's and does not involve a realization.

Question 8

Julian is operating an illegal gambling operation. Even though the income is not legal, it is classified as earned.

Accepted Answer

Income earned from illegal activities is still considered earned income, even if it is not legal. However, it is important to note that engaging in illegal activities is not condoned and may result in legal consequences.

Question 9

Ron won a $25,000 award for his research in microbiology and he immediately transferred the prize to his brother who does similar research. The income is excluded from Ron's taxable income.

Accepted Answer

The transfer of the award to his brother is considered a gift and therefore may be subject to gift tax laws. Additionally, if Ron earned the award for work done as part of his employment or business, it may be considered taxable income.

Question 10

Rachael purchased 300 shares of Smelt, Inc. stock for $25 per share. At the end of the year, the stock price has risen to $30 per share. Rachael does not recognize taxable income even though there has been a $1,500 increase in wealth.

Accepted Answer

Rachael does not recognize taxable income unless she sells the shares and realizes a capital gain. Since she has not sold the shares, the increase in value is considered unrealized and not taxable.

Question 11

According to the U.S. Supreme Court, income may be defined as the gain derived from capital, from labor, or from both combined provided it is understood to include profit gained through sale or conversion of capital assets.

Accepted Answer

This definition of income was established by the U.S. Supreme Court in the case of Eisner v. Macomber in 1920.

Question 12

The holding period for receiving long-term capital gain treatment is 12 months or more.

Accepted Answer

The answer of The holding period for receiving long-term capital...

Question 13

Carlotta finds a chest inscribed "Sinbad" that contains $250,000 of cash while diving among the coral reefs off the Virgin Islands. The US Customs and the DEA deny knowledge of the cash, so Carlotta keeps it. I. Carlotta would not recognize any gross income if the chest contained jewels valued at $250,000, rather than the cash. II. Recognition is necessary because Carlotta has an increase in wealth. III. Recognition will not occur because the windfall would not be considered as derived from capital or from labor. IV. The All-inclusive Income Concept explains the recognition of the cash as income.

Accepted Answer

Statement I is incorrect because the fair market value of jewels found by diving and sold for $250,000 would be taxable as gross income to Carlotta. Statement II is correct because recognition of income is necessary whenever there is an increase in wealth. Statement III is incorrect because the source of the windfall is not relevant to whether it must be recognized as income. Statement IV is correct because the All-inclusive Income Concept requires recognition of all realized income, including windfalls like finding cash in a chest while diving.

Question 14

Net collectibles gains are taxed at a maximum rate of 25 percent.

Accepted Answer

The answer of Net collectibles gains are taxed at a...

Question 15

For any unrecovered portion of an annuity investment, the taxpayer is allowed a deduction in the year of death.

Accepted Answer

This is true according to IRS regulations. If the annuity owner dies before receiving the full amount of their annuity investment, the unrecovered portion is allowed as a deduction on the taxpayer's final income tax return.

Question 16

Friendly Finance loans Anne $10,000 and she will pay $13,130 at he end of three years. Since Friendly is on a cash basis, it will recognize the $3,130 interest income when the loan is repaid.

Accepted Answer

The answer of Friendly Finance loans Anne $10,000 and she...

Question 17

Brandon and Judy divorce during the year and agree that Brandon will pay Judy $24,000 a year in alimony. Brandon will be able to reduce his income by $24,000, but Judy does not have to report any income since it was not earned..

Accepted Answer

Under the Tax Cuts and Jobs Act of 2017, for divorce agreements executed after December 31, 2018, alimony payments are no longer deductible for the payer, and the recipient does not include them as taxable income.

Question 18

Which of the following constitutes a realization? I. Oak Ridge Coal Company's coal mine reserves were recently appraised at $5,750,000 more than the previous year's appraisal. II. Lea's employer gives her and all other salaried employees) a weekend in Chicago in recognition of their efforts to make this a successful year.

Accepted Answer

A realization is when an intangible asset or liability becomes tangible, such as when an asset is sold or a liability is paid off. Statement I is not a realization because it is simply an increase in the appraised value of an asset. Statement II is not a realization because it is a recognition or reward for employees and does not involve a tangible asset or liability.

Question 19

Which of the following constitutes a realization? I. Jamie prepares a will for Wilson. He pays her by painting her house. II. Jones' cow gives birth. The calf will become a member of Jones' feeder cattle herd. III. Oak Ridge Coal Company's coal mine reserves were recently appraised at $5,750,000 more than the previous year's appraisal. IV. Lea's employer gives her and all other salaried employees) a weekend in Orlando in recognition of their efforts to make this a successful year.

Accepted Answer

A realization is a measurable event that affects the financial statements of a company. 
Statement I is not a realization because it is a barter transaction and there is no cash involved. 
Statement II is a realization because the birth of the calf increases the value of Jones' feeder cattle herd. 
Statement III is a realization because the increase in the appraised value of the coal mine reserves will have an impact on the financial statements of Oak Ridge Coal Company. 
Statement IV is not a realization because it is a non-monetary reward and does not affect the financial statements of Lea's employer. 
Therefore, only statements I and IV are incorrect while statements II and III are correct. The best choice is D.

Question 20

An accrual basis taxpayer does not have income until there is an actual or constructive receipt of income earned.

Accepted Answer

An accrual basis taxpayer recognizes income when it is earned, not necessarily when it is received. This method accounts for income at the time the earnings process is complete and revenue is measurable, regardless of when cash is received.

Quiz 3: Income Sources