Question 1

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

Accepted Answer

The realization requirement means that a taxpayer only has to pay taxes when they sell an asset and realize a gain, which gives an incentive to sell assets that have gained value. On the other hand, there is no tax on assets that have decreased in value until they are actually sold, so there may be an incentive to sell those assets as well.

Question 2

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

Ralph can elect to amortize the discount over the ten-year period.

Question 3

ABC Corporation declared a dividend for taxpayers of record as of December 24, 2016. The dividend checks were mailed on December 31, 2016. Ed, a cash basis shareholder, received the dividend check on January 2, 2017. Ed cannot delay reporting the income from the dividend until 2017.

Accepted Answer

Ed, as a cash basis taxpayer, reports income when it is actually or constructively received. Since he received the check in 2017, he reports the income in 2017.

Question 4

In December 2016, Mary collected the December 2016 and January 2017 rent from a tenant. Mary is a cash basis taxpayer. The amount collected in December 2016 for the 2017 rent should be included in her 2017 gross income.

Accepted Answer

For a cash basis taxpayer, income is reported in the year it is received. Since Mary received the rent in December 2016, it should be included in her 2016 gross income, not 2017.

Question 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 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

According to the cash basis method of taxation, income is recognized when it is received, regardless of who benefits from the income. In this case, even though the $60 is being paid directly to the bank, it is still considered income to Jessica and must be included in her gross income.

Question 6

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

Accepted Answer

Painting his own house would not result in taxable income for Barney, as it is considered a personal expense and not a source of income.

Question 7

On January 1, 2017, 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 2018.

Accepted Answer

The taxpayer should recognize the revenue over the term of the contract based on the percentage of completion method. For a 36-month contract, each month represents 1/36th of the total contract. Therefore, in 2018 (the second year of the contract), the taxpayer should recognize 1/36th of the total revenue ($2,400) for that year, which equals $1,600.

Question 8

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

Accepted Answer

The principle of conservatism is designed to be cautious and conservative when estimating uncertain amounts, which may lead to understating assets or overstating liabilities. However, when it comes to measuring taxable income, the principle of conservatism may not be suitable, as it may result in reducing taxable income by overstating expenses or understating revenues, which can potentially lead to tax evasion. Therefore, the principle of conservatism needs to be applied with caution in the context of measuring taxable income.

Question 9

In 2017, 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 2018. The team accepted the counteroffer. Juan constructively received $3 million in 2017.

Accepted Answer

Since Juan is a cash basis taxpayer, he would only recognize income when he actually receives the payment. Therefore, he would not have constructively received the $3 million in 2017, but rather when he receives the $900,000 payments in 2018 and the following years.

Question 10

On December 1, 2016, Daniel, an accrual basis taxpayer, collects $12,000 rent for December 2016 and $12,000 for January 2017. Daniel must include the $24,000 in 2016 gross income.

Accepted Answer

According to the accrual basis of accounting, income is recognized when it is earned, regardless of when payment is received. In this case, Daniel earned the rent for both December 2016 and January 2017 on December 1, 2016, so he must include the entire $24,000 in his 2016 gross income.

Question 11

An advance payment received in June 2017 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 answer of An advance payment received in June 2017...

Question 12

Judy is a cash basis attorney. In 2017, 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 2017.

Accepted Answer

As a cash basis taxpayer, Judy is required to recognize the full value of the stock she received as gross income in the year she received it, regardless of any subsequent fluctuations in value. Therefore, she must recognize $4,000 of gross income from the stock for 2017.

Question 13

A sole proprietorship purchased an asset for $1,000 in 2016 and its value was $1,500 at the end of 2016. In 2017, the sole proprietorship sold the asset for $1,400. The sole proprietorship realized a taxable gain of $400 in 2017 but an economic loss of $100 in 2017.

Accepted Answer

The taxable gain is calculated based on the difference between the sale price ($1,400) and the purchase price ($1,000), resulting in a $400 gain. The economic loss considers the change in value from the end of 2016 ($1,500) to the sale price in 2017 ($1,400), resulting in a $100 loss.

Question 14

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

Just because an accounting method is consistent with GAAP does not mean it is automatically acceptable for tax purposes. The IRS has its own set of rules and guidelines for measuring income for tax purposes. The taxpayer must ensure that their method of accounting is also acceptable for tax purposes.

Question 15

In 2007, Terry purchased land for $150,000. In 2017, 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

The payment received by Terry is considered a return of capital because it is a reimbursement of the cost of the land.

Question 16

A cash basis taxpayer purchased a certificate of deposit for $1,000 on July 1, 2015 that will pay $1,100 upon its maturity on June 30, 2017. The taxpayer must recognize a portion of the income in 2016.

Accepted Answer

A cash basis taxpayer must recognize income when it is received, so when the certificate of deposit matures and the taxpayer receives the $1,100, that amount will be recognized as income. However, if the taxpayer sells the certificate of deposit before it matures, any gain or loss on the sale would be recognized in the year of sale.

Question 17

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

Economic income includes all forms of income, including unrealized gains or losses on investments. Since Nicholas's stock decreased in value, this loss would be considered in his economic income but not in his gross income for tax purposes, as it was an unrealized loss (he did not sell the stock). His gross income for tax purposes would only include the salary earned, not the decrease in stock value or the taxes withheld.

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

Even though Fred directed the publisher to make the royalty check payable to his mother, he is still considered the owner of the income and must include it in his own gross income. This is because he is the one who wrote the book and is receiving the royalties for his work, even if he is choosing to use the money to support his mother.

Question 19

At the beginning of 2017, 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 2017, and $3,600 from the Series EE bonds in 2026.

Accepted Answer

The income from the certificate of deposit should be recognized over the 3-year period, not entirely in 2017. The Series EE bond interest is recognized when the bond matures or is redeemed, not annually.

Question 20

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

The statement is correct. The constructive receipt doctrine is only applicable to cash basis taxpayers, and not to accrual basis taxpayers. Accrual basis taxpayers must recognize income when it is earned, regardless of whether or not they have actually received the payment.

Quiz 4: Gross Income: Concepts and Inclusions