Question 1

A cash basis taxpayer purchased a certificate of deposit for $1,000 on July 1,2013 that will pay $1,100 upon its maturity on June 30,2015.The taxpayer must recognize a portion of the income in 2014.

Accepted Answer

The difference between the issue price of $1,000 and the amount due at maturity of $1,100 is "original issue discount" that must be amortized.The amortized amount is added to gross income for each year the certificate is held.

Question 2

The realization requirement gives an incentive to own assets that have increased in value and to sell assets whose value has decreased.

Accepted Answer

Generally,the tax law follows the realization requirement.Thus,economic gains and losses are not recognized until the assets are sold or exchanged.The sale at a loss,assuming the loss is deductible,will result in after-tax proceeds greater than the value of the asset sold.If the asset has increased in value,the after­tax proceeds will be less than the value of the asset sold,decreasing the taxpayer's net worth computed at market values.

Question 3

Jessica is a cash basis taxpayer.When Jessica failed to repay a loan,the bank garnished her salary.Each week
$60 was withheld from Jessica's 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.

Accepted Answer

Income is generally taxed to the person who earns the income,regardless of who actually receives the income.Moreover,Jessica received the benefit of the income in that her liability was paid.

Question 4

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.

Accepted Answer

The two systems have different objectives.The primary goal of GAAP is to protect investors,while the goal of the income tax system is the equitable collection of revenues.Therefore the requirements of the two systems sometimes differ.

Question 5

Judy is a cash basis attorney.In 2014,she performed services in connection with the formation of a corporation and received stock with a value of $4,000 for her services.By the end of the year,the value of the stock had decreased to $2,000.She continued to hold the stock.Judy must recognize $4,000 of gross income from the stock for 2014.

Accepted Answer

Judy must recognize the income that relates to the services she rendered in 2014.Therefore,Judy must recognize gross income of $4,000 in 2014.The decline in value of the stock is not deductible because the loss has not been realized.

Question 6

ABC Corporation declared a dividend for taxpayers of record as of December 24,2013.The dividend checks were mailed on December 31,2013.Ed,a cash basis shareholder,received the dividend check on January 2,2014.Ed cannot delay reporting the income from the dividend until 2014.

Accepted Answer

The income was not available to Ed until 2014.

Question 7

Nicholas owned stock that decreased in value by $20,000 during the year,but he did not sell the stock.He earned $45,000 salary,but received only $34,000 because $11,000 in taxes were withheld.Nicholas saved $10,000 of his salary and used the remainder for personal living expenses.Nicholas's economic income for the year exceeded his gross income for tax purposes.

Accepted Answer

Nicholas's economic income would be reduced by the unrealized losses on his stock.However,these unrealized losses are not recognized for tax purposes until the securities are sold.

Question 8

Barney painted his house which saved him $3,000.According to the realization requirement,Barney must recognize $3,000 of income.

Accepted Answer

Barney did not realize income because he did not engage in a transaction with another party.

Question 9

On January 1,2014,an accrual basis taxpayer entered into a contract to provide termite inspection service each month for 36 months.The amount received for the contract was $2,400.The taxpayer should report $1,600 of income in 2015.

Accepted Answer

The prepaid income cannot be deferred beyond the tax year following the year of receipt.
Therefore,the taxpayer should report $800 of income in 2014 and $1,600 in 2015.

Question 10

In 2014,Juan,a cash basis taxpayer,was offered $3 million for signing a professional baseball contract.He counter offered that he would receive $900,000 per year for 4 years beginning in 2015.The team accepted the counteroffer.Juan constructively received $3 million in 2014.

Accepted Answer

The income was not constructively received in 2014 by Juan because he did not have the right to receive the income in that year.The $3 million offer was merely part of Juan's contract negotiations.

Question 11

An advance payment received in June 2014 by an accrual basis and calendar year taxpayer for services to be provided over a 36-month period can be spread over four tax years.

Accepted Answer

The income from advance payments for services received by an accrual basis taxpayer cannot be deferred beyond the tax year following the year of receipt.The scenario described in the question relates to advance payments for goods received by an accrual basis taxpayer.

Question 12

At the beginning of 2014,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 2014,and $3,600 from the Series EE bonds in 2023.

Accepted Answer

The income from the certificate of deposit must be amortized over the three-year period as original issue discount.The Series EE bonds are also original issue discount instruments,but the law permits the taxpayer to defer the income until maturity.

Question 13

In 2005,Terry purchased land for $150,000.In 2014,Terry received $10,000 from a local cable television company in exchange for Terry allowing the company to run an underground cable across Terry's property.Terry is not required to recognize income from receiving the $10,000 because it was a return of his capital invested in the land.

Accepted Answer

Terry does not recognize income,but he must reduce his basis for the land by $10,000.The $10,000 received is a recovery of his capital.

Question 14

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.

Accepted Answer

Cash basis taxpayers must recognize income when it is actually or constructively received.The income is constructively received when it is made available to the taxpayer.Accrual basis taxpayers generally report income when they have earned the right to receive it.

Question 15

On December 1,2014,Daniel,an accrual basis taxpayer,collects $12,000 rent for December 2014 and $12,000 for January 2015.Daniel must include the $24,000 in 2014 gross income.

Accepted Answer

Both payments must be included in Daniel's 2014 gross income.Prepaid rent income cannot be deferred until earned.

Question 16

The financial accounting principle of conservatism is not well-suited to the task of measuring taxable income.

Accepted Answer

As the Supreme Court reasoned in Thor Power Tool Co. ,the conservatism principle would not serve the government's goal of raising revenues.

Question 17

Ralph purchased his first Series EE bond during the year.He paid $709 for a 10-year bond with a $1,000 maturity value.The yield to maturity on the bonds was 3.5%.Ralph is not required to recognize the $291 ($1,000 - $709)original issue discount until the bond matures.However,Ralph can elect to amortize the discount over the ten-year period.

Accepted Answer

Series EE bonds are not subject to the original issue discount rules.Note,however,that an election can be made to amortize the discount.

Question 18

Fred is a full-time teacher.He has written a book and receives royalties from it.Fred's mother,Mabel,is age 65 and lives on her Social Security benefits and gifts from her son,Fred.This year Fred directed the publisher to make the royalty check payable to Mabel because she needs the money for support.Fred must include the amount of the royalty check in his gross income.

Accepted Answer

The royalties must be included in the gross income of Fred,the taxpayer who earned it.

Question 19

In December 2013,Mary collected the December 2013 and January 2014 rent from a tenant.Mary is a cash basis taxpayer.The amount collected in December 2013 for the 2014 rent should be included in her 2014 gross income.

Accepted Answer

The cash basis taxpayer must report the rent income in gross income for the year it is received,2013,rather than the year in which it is earned.

Question 20

A sole proprietorship purchased an asset for $1,000 in 2014 and its value was $1,500 at the end of 2014.In 2015,the sole proprietorship sold the asset for $1,400.The sole proprietorship realized a taxable gain of $400 in 2015 but an economic loss of $100 in 2015.

Accepted Answer

The realization requirement was not satisfied until 2014,and thus $400 in gross income was recognized in that year.Under the economic concept of income,the asset declined in value by $100 in 2015 and thus a loss was incurred in that year.

Quiz 4: Gross Income: Concepts and Inclusions