Question 1

On January 5, 2018, Tim purchased a bond paying interest at 6% for $30,000. On March 31, 2018, he gave the bond to Jane. The bond pays $1,800 interest on December 31. Tim and Jane are cash basis taxpayers. When Jane collects the interest in December 2018:

Accepted Answer

Since Tim and Jane are both cash basis taxpayers, the interest income is taxable to the person who is holding the bond at the time the interest is paid.

Tim held the bond for the entire year of 2018, so he is deemed to have received the interest income for the year. However, he gave the bond to Jane on March 31, so he must give her a pro-rata portion of the interest income that accrued while he owned the bond (Jan 1 - Mar 31).

The bond pays $1,800 interest on December 31, so the interest accrued from Jan 1 - Mar 31 is (3/12) x $1,800 = $450.

Therefore, Jane reports $1,350 of interest income in 2018 (the remaining 9/12 of the interest), and Tim reports $450 of interest income in 2018 (the portion of the interest that accrued while he owned the bond).

Question 2

Wayne owns a 30% interest in the capital and profits of Emerald Company (a calendar year partnership). For tax year 2018, 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 2018, Wayne's gross income from the partnership is:

Accepted Answer

Wayne's gross income from the partnership is based on his share of the partnership's net income, not on his withdrawals or additional investments. The partnership's net income is $240,000 ($900,000 revenue - $660,000 expenses). Wayne's 30% share of this net income is $72,000 (30% of $240,000).

Question 3

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.

Accepted Answer

Only statement I and II are true. Income from property is taxed to the person who owns the property, and income from services is taxed to the person who earns the income. Statements III and IV are false. The assignee of income from property is not necessarily responsible for paying tax on that income; it depends on the terms of the assignment. Similarly, the person who receives the benefit of the income may not always be the one responsible for paying the tax on that income.

Question 4

Darryl, a cash basis taxpayer, gave 1,000 shares of Copper Company common stock to his daughter on September 29, 2018. 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, 2018.

Accepted Answer

The daughter must recognize the income because she owned the stock when the dividend was declared and she received the $2,000.

Question 5

With respect to the prepaid income from services, which of the following is true?

Accepted Answer

A cash basis taxpayer must report all of the income in the year received, as they recognize income when it is actually received, regardless of when the services are performed.

Question 6

Under the alimony rules:

Accepted Answer

Under the tax laws effective before 2019, alimony payments were deductible by the payer and included in the recipient's gross income. However, for agreements entered into after December 31, 2018, alimony is neither deductible by the payer nor taxable to the recipient. Since the agreement in option C is from 2015, the old rules apply, making the alimony taxable to the recipient.

Question 7

Travis and Andrea were divorced in 2016. Their only marital property consisted of a personal residence (fair market value of $400,000, cost of $200,000), and publicly-traded stocks (fair market value of $800,000, cost basis of $500,000). Under the terms of the divorce agreement, Andrea received the personal residence and Travis received the stocks. In addition, Andrea was to receive $50,000 for eight years.
I. If the $50,000 annual payments are to be made to Andrea or her estate (if she dies before the end of the eight years), the payments will qualify as alimony.
II. Andrea has a taxable gain from an exchange of her one-half interest in the stocks fo Travis' one-half interest in the house and cash.
III. If Travis sells the stocks for $900,000, he must recognize a $400,000 gain.

Accepted Answer

Explanation: III is true because Travis's gain is calculated as the selling price ($900,000) minus his cost basis ($500,000), resulting in a $400,000 gain. I is false because alimony payments must cease upon the death of the recipient to qualify as alimony. II is false because the division of property in a divorce is generally not a taxable event.

Question 8

Theresa, a cash basis taxpayer, purchased a bond on July 1, 2014, for $10,000, plus $400 of accrued interest. The bond paid $800 of interest each December 31. On March 31, 2018, she sold the bond for $9,800, which included $200 of accrued interest.

Accepted Answer

Theresa has $200 interest income from the accrued interest included in the sale price and a $400 loss from the bond ($10,000 purchase price - $9,800 sale price excluding interest).

Question 9

Teal company is an accrual basis taxpayer. On December 1, 2018, a customer paid for an item that was on hand, but the customer wanted the item delivered in early January 2019. Teal delivered the item on January 4, 2019. Teal included the sale in its 2018 income for financial accounting purposes.

Accepted Answer

Teal is an accrual basis taxpayer, meaning that income is recognized when it is earned, regardless of when payment is received. In this case, Teal had already earned the income in 2018 when the customer paid for the item that was on hand. Delivery in 2019 is irrelevant. Therefore, Teal must recognize the income in 2018.

Question 10

Jim and Nora, residents of a community property state, were married in early 2017. Late in 2017 they separated, and in 2018 they were divorced. Each earned a salary, and they received income from community owned investments in all relevant years. They filed separate returns in 2017 and 2018.

Accepted Answer

The answer of Jim and Nora, residents of a community...

Question 11

Orange Cable TV Company, an accrual basis taxpayer, allows its customers to pay by the year in advance ($600 per year), or two years in advance ($960). In September 2018, the company collected the following amounts applicable to future services: 
As a result of the above, Orange Cable should report as gross income for 2019:

Accepted Answer

The answer of Orange Cable TV Company, an accrual basis...

Question 12

On November 1, 2018, Bob, a cash basis taxpayer, gave Dave common stock. On October 30, 2018, the corporation had declared the dividend payable to shareholders of record as of November 22, 2018. The dividend was paid on December 15, 2018. The corporation has paid the $1,200 dividend once each year for the past ten years, during which Bob owned the stock. When Dave collected the dividend on December 15, 2018:

Accepted Answer

The answer of On November 1, 2018, Bob, a cash...

Question 13

Jerry purchased a U.S. Series EE savings bond for $744. The bond has a maturity value in 10 years of $1,000 and yields 3% interest. This is the first Series EE bond that Jerry has ever owned.

Accepted Answer

Jerry can defer the interest income until the bond matures in 10 years, as Series EE bonds allow for tax deferral on interest until redemption or maturity.

Question 14

Office Palace, Inc., leased an all-in-one printer to a new customer, Ashley, on December 27, 2018. The printer was to rent for $600 per month for a period of 36 months beginning January 1, 2019. Ashley was required to pay the first and last month's rent at the time the lease was signed. Ashley was also required to pay a $1,500 damage deposit. Office Palace must recognize as income for the lease:

Accepted Answer

Office Palace must recognize $1,200 in 2018 as income for the lease. This is because Office Palace is an accrual basis taxpayer, and under the accrual method of accounting, revenue is recognized when it is earned, regardless of when cash is received. In this case, Office Palace earned the $1,200 in rent for the first and last month of the lease in 2018, even though the cash was not received until 2019.

Question 15

Daniel purchased a bond on July 1, 2018, at par of $10,000 plus accrued interest of $300. On December 31, 2018, Daniel collected the $600 interest for the year. On January 1, 2019, Daniel sold the bond for $10,200.

Accepted Answer

Daniel recognized $300 of interest income in 2018 because he purchased the bond on July 1, 2018, and accrued interest of $300. He also recognized $600 of interest income in 2018 because he collected the interest for the year on December 31, 2018. Daniel recognized a gain of $200 on the sale of the bond in 2019 because he sold the bond for $10,200, which is $200 more than the par value of $10,000.

Question 16

Harry and Wanda were married in Texas, a community property state, but moved to Virginia, a common law state. The calculation of their income on a joint return:

Accepted Answer

The calculation of their income on a joint return will not change as a result of changing their state of residence. Federal tax laws determine how income is taxed, regardless of state laws or residency. However, state tax laws may differ in how they apply to various forms of income.

Question 17

The Maroon & Orange Gym, Inc., uses the accrual method of accounting. The corporation sells memberships that entitle the member to use the facilities at any time. A one-year membership costs $480 ($480/12 = $40 per month)? a two-year membership costs $720 ($720/24 = $30 per month). Cash payment is required at the beginning of the membership period. On July 1, 2018, the company sold a one-year membership and a two-year membership. For financial reporting purposes, Maroon reports the membership income ratably over the number of months involved. The company should report as gross income from the two contracts:

Accepted Answer

For the one-year membership, the company should recognize $40 per month for 12 months, totaling $480. Since the membership was sold on July 1, 2018, the company should recognize 6 months of revenue in 2018, totaling $240.

For the two-year membership, the company should recognize $30 per month for 24 months, totaling $720. Since the membership was sold on July 1, 2018, the company should recognize 18 months of revenue in 2018, totaling $540.

Therefore, the total gross income from the two contracts that should be recognized in 2018 is $240 + $540 = $780. Thus, the correct answer is option D.

Question 18

Mike contracted with Kram Company, Mike's controlled corporation. Mike was a medical doctor and the contract provided that he would work exclusively for the corporation. No other doctor worked for the corporation. The corporation contracted to perform an operation for Rosa for $8,000. The corporation paid Mike $6,500 to perform the operation under the terms of his employment contract.

Accepted Answer

Mike's gross income is $6,500 as per the terms of his employment contract with Kram Company. The $8,000 paid by Rosa is income for the corporation, not for Mike personally.

Question 19

The Green Company, an accrual basis taxpayer, provides business-consulting services. Clients generally pay a retainer at the beginning of a 12-month period. This entitles the client to no more than 40 hours of services. Once the client has received 40 hours of services, Green charges $500 per hour. Green Company allocates the retainer to income based on the number of hours worked on the contract. At the end of the tax year for contracts entered into for the current year, the company had $50,000 of unearned revenues from these contracts. The company also had $10,000 in unearned rent income received this year from excess office space leased to other companies. Based on the above, Green must include in gross income for the subsequent tax year:

Accepted Answer

The company is using the accrual basis of accounting, which means that income is recognized when earned, regardless of whether it has been received yet. Therefore, the $50,000 of unearned revenues constitute income that has been earned but not yet received. The $10,000 of unearned rent income, on the other hand, is not related to the company's main business of providing consulting services and is therefore not included in the calculation of gross income for the subsequent tax year. Therefore, the correct answer is B) $50,000.

Question 20

With respect to income from services, which of the following is true?

Accepted Answer

For an accrual basis taxpayer, income from services is recognized as earned or performed, regardless of when payment is received. Therefore, the entire amount of the service contract sold in Question C is recognized as income in 2018, the year in which it was sold.

Quiz 4: Gross Income: Concepts and Inclusions