Exam 5: Gross Income: Exclusions

In the case of interest income from state and Federal bonds:

Both Sally and Ed own property with a fair market value less than the amount of the outstanding mortgage on the property and also less than the original cost basis. Each of them was able to convince the mortgage holder to reduce the principal amount on the mortgage. Sally's mortgage is on her personal residence and Ed's mortgage is on rental property he owns. Both debts are recourse. a. Explain whether each of these individuals has realized income from the reduction in the debt. b. Assume that under the current system of measuring income, each of these taxpayers realized income from the reductions in the mortgages. Should either of these taxpayers be permitted to exclude any of the debt discharge income?

Sandy is married, files a joint return, and expects to be in the 24% marginal tax bracket for the foreseeable future. All of his income is from salary and all of it is used to maintain the household. He has a paid up life insurance policy with a cash surrender value of $100,000. He paid $60,000 of premiums on the policy. His gain from cashing in the life insurance policy would be ordinary income. If he retains the policy, the insurance company will pay him at least $3,000 (3%) interest each year. Sandy thinks he can earn a higher return if he cashes in the policy and invests the proceeds. a. What before-tax rate of return would Sandy be required to earn on the proceeds from cashing in the policy to equal the return earned with the insurance company? b. Assume Sandy estimates he can earn a 6% before-tax rate of return on the proceeds from cashing in the policy. Assume he can earn a 6% return for the remainder of his life and that he will reinvest all earnings at the same 6% before-tax rate of return. If Sandy expects to live 10 more years, which alternative will yield the greater amount to his beneficiaries upon his death? (Given: The future value of an annuity in 10 years assuming a 4.32% after-tax return is 12.19. The future value of an annuity in 10 years assuming a 2.16% return is 11.03).

Harold bought land from Jewel for $150,000. Harold paid $50,000 cash and gave Jewel an 8% note for $100,000. The note was to be paid over a five-year period. When the balance on the note was $80,000, Jewel began having financial difficulties. To accelerate her cash inflows, Jewel agreed to accept $60,000 cash from Harold in final payment of the note principal.

Sharon had some insider information about a corporate takeover. She unintentionally informed a friend, who immediately bought the stock in the target corporation. The takeover occurred and the friend made a substantial profit from buying and selling the stock. The friend told Sharon about his stock dealings and gave her a pearl necklace because she "made it all possible." The necklace was worth $10,000, but she already owned more jewelry than she desired.

In 2019, Theresa was in an automobile accident and suffered physical injuries. The accident was caused by Ramon's negligence. In 2020, Theresa collected from his insurance company. She received $15,000 for loss of income, $10,000 for pain and suffering, $50,000 for punitive damages, and $6,000 for medical expenses that she had deducted on her 2019 tax return (the amount in excess of 10% of adjusted gross income). As a result of this, Theresa's 2020 gross income is increased by $56,000.

What are the tax problems associated with payments received by a wife from her deceased husband's employer? (Assume the wife renders no services to the employer.)

Julie was suffering from a viral infection that caused her to miss work for 90 days. During the first 30 days of her absence, she received her regular salary of $8,000 from her employer. For the next 60 days, she received $12,000 under an accident and health insurance policy purchased by her employer. The premiums on the health insurance policy were excluded from her gross income. During the last 30 days, Julie received $6,000 on an income replacement policy she had purchased. Of the $26,000 she received, Julie must include in gross income:

Turquoise Company purchased a life insurance policy on the company's chief executive officer, Joe. After the company had paid $400,000 in premiums, Joe died, and the company collected the $1.5 million face amount of the policy. The company also purchased group term life insurance on all its employees. Joe had included $16,000 in gross income for the group term life insurance premiums. Joe's widow, Rebecca, received the $100,000 proceeds from the group term life insurance policy.

Agnes receives a $5,000 scholarship that covers her tuition at Parochial High School. She may not exclude the $5,000 because the exclusion applies only to scholarships to attend college.

In December 2019, Emily, a cash basis taxpayer, received a $2,500 cash scholarship for the spring semester of 2020. However, she did not use the funds to pay the tuition until January 2020. Emily can exclude the $2,500 from her gross income in 2019.