CHAPTER 5-TAX GROSS INCOME-EVXCLUSION

1. For a person who is in the 35% marginal tax bracket, $1,000 of tax-exempt income is

equivalent to $1,350 of income that is subject to tax.

a. True

b. False

ANSWER: False

RATIONALE: $1,000 of taxexempt income is equivalent to $1,538 [($1,000)/(1 .

35)] of income that is subject to taxation. Income before tax of $1,538
yields $1,000 [$1,538 (1 .35)] of aftertax income.

2. John told his nephew, Steve, if you maintain my house when I cannot, I will leave the

house to you when I die." Steve maintained the house and when John died Steve

inherited the house. The value of the residence can be excluded from Steves gross

income as an inheritance.

a. True

b. False

ANSWER: False

RATIONALE: The house was received as a payment for services, rather than as a
bequest.

3. Brooke works part-time as a waitress in a restaurant. For groups of 7 or more

customers, the customer is charged 15% of the bill for Brookes services. For parties of

less than 7, the tips are voluntary. Brooke received $11,000 from the groups of 7 or

more and $7,000 in voluntary tips from all other customers. Using the customary 15%
 rate, her voluntary tips would have been only $6,000. Brooke must include $18,000

($11,000 + $7,000) in gross income.

a. True

b. False

ANSWER: True

RATIONALE: The tips are compensation for income tax purposes because they are

received for her services, rather than as a result of the customers

detached, disinterested generosity (i.e., not a gift). She must include

$18,000 ($11,000 + $7,000) in her gross income.

4. Mel was the beneficiary of a $45,000 group term life insurance policy on his wife. His

wifes employer paid all of the premiums on the policy. Mel used the life insurance

proceeds to purchase a United States Government bond, which paid him $2,500

interest during the current year. Mels Federal gross income from the above is $2,500.

a. True

b. False

ANSWER: True

RATIONALE: The $2,500 interest on United States Government bonds must be

included in gross income. The life insurance proceeds of $45,000 are
excluded from gross income.
5. Zack was the beneficiary of a life insurance policy on his wife. Zack had paid $20,000

in premiums on the policy. He collected $50,000 on the policy when his wife died

from a terminal illness. Because it took several months to process the claim, the

insurance company paid Zack $53,000, the face amount of the policy plus $3,000

interest. Zack must include $23,000 in his gross income.

a. True

b. False

ANSWER: False

RATIONALE: The interest income of $3,000 is included in gross income because it

represents interest income. The life insurance proceeds of $50,000 are
excludible from gross income under 101(a).

6. Ed died while employed by Violet Company. His wife collected $40,000 on a group

term life insurance policy that Violet provided its employees, and $6,000 of accrued

salary Ed had earned prior to his death. All of the premiums on the group term life

insurance policy were excluded from the Eds gross income. Eds wife is required to

recognize as gross income only the $6,000 she received for the accrued salary.

a. True

b. False

ANSWER: True

RATIONALE: The $6,000 accrued salary Ed had earned must be included in his wifes
gross income. The life insurance proceeds of $40,000 are excluded
under 101(a).

7. Gary cashed in an insurance policy on his life. He needed the funds to pay for his

terminally ill wifes medical expenses. He had paid $12,000 in premiums and he

collected $30,000 from the insurance company. Gary is not required to include the

gain of $18,000 ($30,000 $12,000) in gross income.

a. True

b. False

ANSWER: False

RATIONALE: The exclusion for terminal illness applies to policies on the terminally
ill insured person. Gary did not have the terminal illness.