Chp 5: Gross Income Exclusion

Discussion Question
1. Fred specified in his will that his nephew John should serve as executor of Fred’s estate.
John received $10,000 for serving as executor. Can John exclude the $10,000 from his
gross income? Explain.
No, John cannot exclude $10,000 from his gross income because the $10,000 he receives is
considered income for services he performs.

2. Leonard’s home was damaged by a fire. He also had to be absent from work for several
days to make his home habitable. Leonard’s employer paid Leonard his regular salary,
$2,500, while he was absent from work. In Leonard’s pay envelope was the following
note from the employer: To help you in your time of need. Leonard’s fellow employees
also took up a collection and gave him $900. Leonard spent over $4,000 repairing the fire
damage.
Based on the above information, how much is Leonard required to include in his
gross income?
Based on the above, Leonard can only include $2,500 in his gross income because the amount
he receives from his employer is his regular salary. The amount of $900 cannot be included in
this gross income because it is a nontaxable income that his colleagues donated to him out of
generosity.

3. Billy fell off a bar stool and hurt his back. As a result, he was unable to work for three
months. He sued the bar owner and collected $100,000 for the physical injury and
$50,000 for the loss of income. Billy also collected $15,000 from an income replacement
insurance policy he purchased. Amber was away from work for three months following
heart bypass surgery. Amber collected $30,000 under an income replacement insurance
policy purchased by her employer. Are the amounts received by Billy and Amber treated
the same under the tax law? Explain.
No, the two are not treated under the same tax law. First, Billy gets $150,000 for personal injury
from the bar owner. Billy also claimed another $15,000 from insurance he purchased for income
replacement. Both of these transactions are excluded from Billy’s gross income. Unlike Amber,
the $30,000 she received from her employer as an income replacement will be taxed because the
insurance is not purchased by Amber, so she needs to pay the tax.

4. Holly was injured while working in a factory and received $12,000 as workers’
compensation while she was unable to work because of the injury. Jill, who was self-
employed, was also injured and unable to work. Jill collected $12,000 on an insurance
policy she had purchased to replace her loss of income while she was unable to work.
How much are Holly and Jill each required to include in their gross income?
$12,000 is for Holly as worker’s compensation due to his injury cause in a factory while Jill
faced the same issues as Holly just the only difference is Holly is a factory’s worker while Jill is
self-employed. But Jill can still claim coverage for her injury where she received $12,000 as an
income replacement from the insurance she purchased. Therefore, the money they receive is
excluded from gross income and non-taxable.

5. What is the difference between a cafeteria plan and an employee flexible spending plan?
Cafeteria Plan Flexible Spending Plan
● An employer-provided plan that allows ● A plan that allows employees to modify
employees to choose from a variation in the cafeteria plan to meet and fulfil their
pre-tax benefits . specific needs.

● More complex to operate ● More direct and easy to manipulate.

● Require more time to regulate and ● Not as much time was needed as in
implement. cafeteria plans, because flexible spending
plans only focus on choosing the right
plan for employees.

Computational Exercises
1. Valentino is a patient in a nursing home for 45 days of 2020.While in the nursing home,
he incurs total costs of $13,500. Medicare pays $8,000 of the costs. Valentino receives
$15,000 from his long-term care insurance policy, which pays while he is in the facility.
Assume that the Federal daily excludible amount for Valentino is $380.
Of the $15,000, what amount may Valentino exclude from his gross income?
Total excludible amount = $380 x 45days = $17,100
Actual costs = $13,500
The amount excluded from Valentino’s gross income is, $17,100 - $13,500 = $3,600

2. Ellie purchases an insurance policy on her life and names her brother, Jason, as the
beneficiary. Ellie pays $32,000 in premiums for the policy during her life. When she
dies, Jason collects the insurance proceeds of $500,000.
As a result, how much gross income does Jason report?
$0. The reason is that life insurance was paid to the beneficiary because Ellie's insurance policy
was previously exempt from income tax. As a result, Jason does not need to report gross income
benefits because death benefits are nontaxable. Death benefits can only be taxable in this
scenario where the amount of death benefits is included in the estate and the beneficiary has a
name under the estate, so death benefits are taxable.

3. Leland pays premiums of $5,000 for an insurance policy in the face amount of $25,000
upon the life of Caleb and subsequently transfer the policy to Tyler for $7,500. Over the
years, Tyler pays subsequent premiums of $1,500 on the policy. Upon Caleb’s death,
Tyler receives the proceeds of $25,000.
As a result, what amount is Tyler required to include in his gross income?
$25,000 - $7,500 - $1,500 = $16,000. Therefore, $16,000 is the amount Tyler must include in
his gross income.

4. Jarrod receives a scholarship of $18,500 from East State University to be used to pursue
a bachelor’s degree. He spends $12,000 on tuition, $1,500 on books and supplies, $4,000
for room and board, and $1,000 for personal expenses.
How much may Jarrod exclude from his gross income?
$18,500 - $4,000 - $1,000 = $13,500. Jarrod may exclude $13,500 from his gross income as it is
not excluded from the room and board, and personal expenses that are not considered expenses
for study purposes.

Problem
1. Determine the gross income of the beneficiaries in the following cases:
a. Justin’s employer was downsizing and offered employees an amount equal to one
year’s salary if the employee would voluntarily retire.
The amount Justin receives from his employer for not working must be included in his gross
income. This is because although he has stopped working , he still receives payments.
b. Trina contracted a disease and was unable to work for six months. Because of her
dire circumstances, her employer paid her one-half of her regular salary while she
was away from work.
Trina still needs to include in her gross income from the payment received because her payment
is not a gift because of IRS policy and regulations where whenever an employer gives an
employee something, it still considers a payment even though her employer has just donated it
to her.
c. Coral Corporation collected $1,000,000 on a key person life insurance policy
when its chief executive died. The corporation had paid the premiums on the
policy of $77,000, which were not deductible by the corporation.
The life insurance’s benefits are excluded from Coral Corporation gross income because the
corporation is the key person on the life insurance policy after the chief executive died.
Consequently, Coral Corporation acts as the policy beneficiary upon the insured's death.
d. Juan collected $40,000 on a life insurance policy when his wife, Leona, died in
2020. The insurance policy was provided by Leona’s employer, and the premiums
were excluded from Leona’s gross income as group term life insurance. In 2020,
Juan also collected the $3,500 accrued salary owned to Leono at the time of her
death.
The $40,000 life insurance payment Juan gets is nontaxable because he was the policy
beneficiary on his wife's death. However, the accrued salary of $3,500 is taxable and must be
included in his gross income.

2. What is the taxpayer’s gross income in each of the following situations?

a. Darrin received a salary of $50,000 from his employer, Green Construction.
Darrin’s gross income = $50,000.
 b. In July, Green gave Darrin an all expense paid trip to Las Vegas (value of $3,000)
for exceeding his sales quota.
Darrin’s gross income = $3,000 which is the value for the trip to Las Vegas.
c. Marta received $10,000 from her employer to help her pay medical expenses not
covered by insurance.
Marta’s taxable gross income is $0 where $10,000 is a compensation for Marta from her
employer.
d. Blake received $10,000 from his deceased wife’s employer “to help him in his
time of greatest need”.
It is an excluded gift received by his deceased wife’s employer which Blake needed it.
e. Clint collected $50,000 as the beneficiary of a group term life insurance policy
when his wife died. The premiums on the policy were paid by his decreased wife’s
employer.
Zero because the client is a beneficiary upon the death of his wife and is excluded from gross
income.

Tax Return Problems

1. Alfred E. Old and Beulah A. Crane, each age 42, married on September 7,2017. Alfred
and Beulah will file a joint return for 2019. Alfred’s Social Security number is 111-11-
1109. Beulah’s Social Security number is 123-45-6780, and she adopted “Old” as her
married name. They live at 211 Brickstone Drive, Atlanta, GA 30304.
Alfred was divorced from Sarah Old in March 2016. Under the divorce
agreement, Alfred is to pay Sarah $1,250 per month for the next 10 years or until Sarah’s
death, whichever occurs first. Alfred pays Sarah $15,000 in 2019. In addition, in January
2019, Alfred pays Sarah $50,000, which is responsible for all prior years’ income taxes.
Sarah’s Social Security number is 123-45-6788.
Alfred’s salary for 2019 is $150,000. He is an executive working for Cherry, Inc.
(Federal I.D. No. 98-7654321). As part of his compensation package, Cherry provides
him with group term life insurance equal to twice his annual salary. His employer
withheld $24,900 for Federal income taxes and $8,000 for state income taxes. The proper
amounts were withheld for FICA taxes.
Beulah recently graduated from law school and is employed by Legal Aid Society,
Inc. (Federal I.D. No. 11-1111111), as a public defender. She receives a salary of
$42,000 in 2019. Her employer withheld $7,500 for Federal income taxes and $2,400 for
state income taxes. The proper amounts were withheld for FICA taxes.
Alfred and Beulah had interest income of $500. THey receive a $,1900 refund on
their 2018 state income taxes. They claimed the standard deduction on their 2018 Federal
income tax return. Alfred and Beulah pay $4,500 interest and $1,450 property taxes on
their personal residence in 2019. Their charitable contributions total $2,400 (all to their
church). THey paid sales taxes of $1,400, for which they maintain the receipts. Alfred
and Beulah ahve never owned or used any virtual currency, and they do not want to
contribute to the Presidential Election Campaign.
 Compute the Olds’ net tax payable (or refund due) for 2019. Suggested software:
ProConnect Tax Online.
Calculation Part
Contents Amount ($)

Form 1040
Salary 150,000

Taxable Refund 1,900

Interest Income 500

Total Income 152,400

Minus AGI

Alimony Paid (15,000)

Total Adjusted Gross Income 137,400

Schedule A
(-) Itemized Deductions (refer to schedule A’s calculation) (17,750)

119,650
(-) Exemption (24,400)

Taxable Income 97,250

Total Taxes (refer to calculation A) 30,080

(-) Federal Income Tax 24,900

Tax Payment 24,900

Net Tax Payable (refer to calculation B) 5,180

Calculation A
Since taxable income is $150,000, therefore the tax owned is 24%.
[($150,000 - $85,525) x 24%] + $14,605.50 = $15,474 + $14,605.50 = $30,080
Calculation B
Total Taxes - Total Payment = $30,080 - $24,900 = $5,180

Schedule A’s Calculation

Contents Amount ($)

Income Taxes 8,000

 Real Estate Tax 1,450
Total Taxes 10,850

Interest that Alfred has paid

Home Mortgage 4,500

Gifts 2,400
Total Itemized Deductions 17,750

Chp 6: Deductions and Losses in General

Discussion Question
1. Michael earned $20,000 at the K-M Resort Golf Club during the summer prior to his
senior year in college. He wants to make a contribution to a traditional IRA, but the
amount is dependent on whether it reduces his taxable income. If Michael is going to
claim the standard deduction, will a contribution to a traditional IRA reduce his taxable
income? Explain.
In my point of view, Michael can contribute any amounts that he wants as long as it does not
exceed the amount that he earned, $20,000. Therefore, his contributions can consider as a
deduction for adjusted gross income. Hence, Michael is able to claim the standard deduction.

2. Classify each of the following expenditures paid in 2020 as a deduction for AGI, a
deduction from AGI, or not deductible:
a. Roberto gives cash to his father as a birthday gift. → Not deductible
b. Sandra gives cash to her church. → From AGI
c. Albert pays Dr. Dafashy for medical services rendered. → From AGI
d. Mia pays alimony to Bill. → For AGI
e. Rex, who is self-employed, contributes to his pension plan. → For AGI
f. Bonita pays expenses associated with her rental property. → For AGI

3. Nanette, a single taxpayer, is a first-grade teacher. Potential deductions are charitable

contributions of $800, personal property taxes on her car of $240, and various supplies
purchased for use in her classroom of $225 (none reimbursed by her school). How will
these items affect Nanette’s Federal income tax return for 2020?
Nanette's charitable contributions and personal property tax, which total $1,040, can be
deducted from Adjusted Gross Income. On the other hand, the $225 purchase for her classroom
is a deduction for Adjusted Gross Income.
 4. Monique owns a building that she leaves to an individual who operates a grocery store.
Rent income is $10,000, and rental expenses are $6,000. On what Form 1040 schedule or
schedules are the income and expenses reported?
In this case, Monique should use Schedule E. The purpose of completing Schedule E is when
Monique owns and leases a property; therefore, Monique needs to report income by completing
Schedule E.

Computation Exercises
1. Shanna, a calendar year and cash basis taxpayer, rents property to be used in her business
from Janice. As part of the rental agreement, Shanna pays $8,400 rent on April 1, 2020,
for the 12 months ending March 31, 2021.
a. How much is Shanna’a deduction for rent expense in 2020?
$8,400 is Shanna’s deduction for rent expense for the year 2020.
b. Assume the same facts, except that the $8,400 is for 24 month’s rent ending
March 31, 2022. How much is Shanna’s deduction for rent expense in 2020?
($8,400/ 24 months) x 9 months = $3,150
* Shanna’s deduction for the rent expense in 2020 is $3,150.

2. Vella owns and operates an illegal gambling establishment. In connection with this
activity, he has the following expenses during the year:
Rent $24,000
Bribes 40,000
Total expenses 4,000
Utilities 18,000
Wages 230,000
Payroll taxes 13,800
Property insurance 1,600
Illegal kickbacks 22,000
What are Vella’s total deductible expenses for tax purposes?
Total deductible expenses (Rent + Travel Expenses + Utilities + Wages + Payroll Taxes +
Property Insurance)
= $24,000 + $4,000 + $18,000 + $230,000 + $13,800 + $1,600
= $291,400

Problem
1. Amos is a self-employed tax attorney. He and Monica, his employee, attend a tax
conference in Dallas sponsored by the American Institute of CPAs. The following
expenses are incurred during the trip:
Amos ($) Monica ($)
Conference registration 900 900

Airfare 1,200 700

 Taxi fares 100 0
Lodging in Dallas 750 300

a. Amos pays for all of these expenses. Calculate the effect of these expenses on
Amos’s AGI.
The total cost of reducing his AGI is $4,850. The reason he can claim them in AGI is because
all the expenses he paid are related to his tax law practice.
Calculation:
Conference Registration = $(900 + 900) = $1,800
Airfare = $(1,200 + 700) = $1,900
Taxi Fares = $(100 + 0) = $100
Logging in Dallas -$(750 + 300) = $1,050
Total expenses = $4,850
b. Would your answer to part (a) change if the American Bar Association had
sponsored the conference? Explain.
Well, I think no because all the expenses above are related with his business which also as a tax
attorney.

2. Fynn incurred and paid the following expenses during 2020:

● $50 for a ticket for running a red light while he was commuting to work.
● $100 for a ticket for parking in a handicapped parking space.
● $200 to an attorney to represent him in traffic court as to the two tickets.
● $500 to an attorney to draft an agreement with a tenant for a one-year lease on an
apartment that Fynn owns.
● $1,000 to an attorney to negotiate a reduction in his child support payments.
● $2,500 to an attorney to negotiate a reduction in his qualified alimony payments to
a former spouse.
Calculate the amount of Fynn’s deductible expenses.
In general, the purpose of deduction is for individual or business’s expenses that can be deduct
from the adjusted gross income while fill in the tax form. So, above expenses, only the expenses
that cost $500 which for an attorney to draft agreement with a tenant on his property is qualify
for deductible expenses because this considers as ordinary and necessary expenses compared to
other expenses. Others expenses is not qualified as deductible expenses because they are
considered as personal expenses.

Tax Return Problem

1. Roberta Santos, age 41, is single and lives at 120 Sandorne Avenue, Springfield,II.
60781. Her Social Security number is 123-45-6780. Roberta has been divorced from her
former husband, Wayne, for three years. She has a son, Jason, who is 17, and a daughter,
June, who is 18. Jason’s Social Security number is 111-11-1112, and June’s is 123-45-
6788. Roberta has never owned or used any virtual currency. She does not want to
contribute $3 to the Presidential Election Campaign Fund.
Roberta, an advertising executive, earned a salary from ABC Advertising of
$80,000 in 2019. Her employer withheld $9,000 in Federal income tax and $3,100 in
state income tax.
Roberta has legal custody of Jason and June. The divorce decree provides that
Roberta is to receive the dependency deductions for the children. Jason lives with his
father during summer vacation. Wayne indicates that his expenses for Jason are $5,500.
Roberta can document that she spent $6,500 for Jason’s support during 2019. In prior
years, Roberta gave a signed Form 8332 to Wayne regarding Jason. FOr 2019, she has
decided not to do so. Roberta provides all of June’s support.
Roberta’s mother died on January 7, 2019. Roberta inherited assets worth
$625,000 from her mother. As the sole beneficiary of her mother’s life insurance policy,
Roberta received insurance proceeds of $300,000. Her mother’s cost basis for the life
insurance policy was $120,000. Roberta’s favorite aunt gave her $13,000 for her birthday
in October.
On November 8, 2019, Roberta sells for $22,000 Amber stock that she had
purchased for $24,000 from her first cousin, Walt, on December 5, 2013. Walt’s cost
basis for the stock was $26,000, and the stock was worth $23,000 on December 5, 2015.
On December 1, 2019, Roberta sold Falcon stock for $13,500. She had acquired the stock
on July 2, 2015, for $8,000.
An examination of Roberta’s records reveals that she received the following:
● Interest income of $2,500 from First Savings Bank.
● Groceries valued at $750 from Kroger Groceries for being the 100,000th
customer.
● Qualified dividend income of $1,800 from Amber.
● Interest income of $3,750 on City of Springfield school bonds.
● Alimony of $16,000 from Wayne; divorce finalized in May 2015.
● Distribution of $4,800 from ST Partnership. Her distribution share of the
partnership passive taxable income was $5,300. She had no prior passive activity
losses. Assume that the qualified business income deduction applies and the W-2
wage limitation does not.
From her checkbook records, she determines that she made the following
payments during 2019:
● Charitable contributions of $4,500 to First Presbyterian Church and $1,500 to the
American Red Cross (proper receipts obtained).
● Paid $5,000 to ECM Hospital for the medical expenses of a friend from work.
● Mortgage interest on her residence of $7,800 to People Bank.
● Property taxes of $3,200 on her residence and $1,100 (ad valorem) on her car.
$800 for landscaping expenses for residence.
● Estimated Federal income taxes of $2,800 and estimated state income taxes of
$1,000.
 ● Medical expenses of $5,000 for her and $800 for Jason. In December, her medical
insurance policy reimbursed $1,500 of her medical expenses.
● A $1,000 ticket for parking in a handicapped space.
● Attorney’s fees of $500 associated with unsuccessfully contesting the parking
ticket.
● Contribution of $250 to the campaign of a candidate for governor.
Because she did not maintain records of the sales tax she paid, she calculates the
amount from the sales tax table to be $994.
Calculate Roberta’s net tax payable or refund due for 2019. Use the appropriate
forms and schedules. Suggested software: ProConnect Tax Online.
In this case, Roberta need to use Form 1040, Schedule A, Schedule B, Schedule D, Form 8949
and Schedule E to calculate the net tax payable or refund due for 2019. The Form 1040 is a form
for US Individual Income Tax Return, Schedule A is for Itemized Deduction, Schedule B is for
Internet and Ordinary Dividends, Schedule D is for Capital Gains and Losses, Form 8949 is for
Sales and other Dispositions of Capotal Assets and last is Schedule E is for Supplement Income
and Loss. Lastly, what I found and calculate, the Roberta’s refund due for 2019 is $366.

Calculation Part:
Contents Amount ($)
Form 1040

Salary 80,000
Taxable Interest 2,500

Dividend Income 1,800

Alimony Received 16,000

Capital Gain (refer to Schedule D) 3,500

Partnerships (written in the Schedule E) 5,300

Prise from Grocery 750

Total Income 109,850

Minus AGI 0
Total Gross Income 109,850

Schedule A
(-) Itemized Deduction (refer to schedule A’s (22,200)
calcualtion)
87,650
 (-) Exemptions (refer to calculation A) (12,000)
Taxable Income 75,650

Total Taxes (refer to calculation B) 12,434

(-) Federal Income Tax (9,000)

(-)Tax Payment (refer to calculation C) (3,800)

Total Payment 12,800

Refund payments (refer to calculation D) 366

Calculation A
Exemption (expenses for his children) = $5,500 + $6,500 = $12,000
Calculation B
Since taxable income is $75,650, therefore the tax owned is 22%.
[$(75,650 - 40,125) x 22%] + $4,617.50 = $7,816 + $4,617.50 = $12,434

Calculation C
Tax Payment = Federal Income Tax + State Income Tax
= $(2,800 + 1,000)
= $3,800

Calculation D
Refund Payment = Total Payment - Total Taxes
= $(12,800 - 12,434)
= $366

Schedule D’s Calculation

Amber’s Stock (5/12/10 – 8/11/15)
$22,000 - $24,000 = -$2,000

Falcon’s Stock (2/07/12 – 1/12/15)

$13,500 - $8,000 = $5,500

Total: $(-2,000 + 5,500) = $3,500

Schedule A’s Calculation

Contents Amount ($)
Income taxes ($3,100 + $1,000) 4,300

Real estate tax 3,200

Personal property tax 1,100
 Total taxes 8,400
Interest that Roberta has paid

Home Mortgage 7,800

Gifts 6,000

Total Itemized Deductions 22,200

References
1. Kagun, J., & Janet Berry-Johnson. (2020, September 17). Deductible. Retrieved from
Investopedia: https://www.investopedia.com/terms/d/deductible.asp#:~:text=For%20tax
%20purposes%2C%20a%20deductible,amount%20of%20income%20taxes%20owed.
2. Kagun, J., & Lea D. Uradu. (2020, June 30). Cafeteria Plan. Retrieved from Investopedia:
https://www.investopedia.com/terms/c/cafeteriaplan.asp
3. Spencer, P. (2020, September 28). Are Life Insurance Death Benefits Subject to Estate Tax?
Retrieved from the Balance: https://www.thebalance.com/are-life-insurance-death-benefits-
subject-to-estate-tax-4012617
4. Withaar, L., & Ashley Donohoe. (2019, March 7). What is Schedule E in Taxation? Retrieved
from Finance Zacks: https://finance.zacks.com/schedule-e-taxation-9475.html