c73f741a-e62b-4639-aa51-056bccd46bb4.doc. Page 1 of 9. Ch12. Compensation LO 1 Discuss and explain the tax implications of compensation in the form of salary and wages from the employee's and employer's perspectives. LO 2 Describe and distinguish the tax implications of various forms of equity-based compensation from the employer's and employee's perspectives. LO 3 Compare and contrast taxable and nontaxable fringe benefits and explain the employee and employer tax consequences associated with fringe benefits. Salaries and Wages Page 1. Employment forms 1. Which of the following forms is filled out by an employee, who is a citizen, at the beginning of an employment relationship? a. Form I-9. c. Form W-4. C b. Form W-2. d. Form 1099. Employees fill out a W-4 to indicate their tax status, number of dependents and other items that affect income tax withholding. 2. Which of the following items is not included on an employee's Form W-2? a. Taxable wages, tips, and compensation c. Value of stock options granted during the year C b. Social Security withholding d. Federal and state income tax withholding Stock options are reported as taxable compensation typically upon vesting. 3. Which of the following statements regarding compensation is false? a. Wages are usually paid by the hour. D b. Salary is usually a form of fixed compensation. c. Bonuses are a form of compensation obtained if certain criteria are met. d. Bonuses paid within 2½ months of year end are included in employee's compensation in the year they were earned. Employees include compensation into income in the year received. 4. Which of the following isn't done by Form W-2? a. Summarizes the employee's taxable salary and wages. C b. Provides annual Federal and state withholding information. c. Indicates whether an employee had more than one employer during the year. d. Generated by an employer annually. The W-2 only provides information about the employer providing the statement. Pages 2, 3 and 4. Withholding from Employee Compensation 5. Which of the following statements regarding income tax withholding is incorrect? a. Withholding tables are designed so that employee withholding approximates the tax liability. B b. Large itemized deductions require the need for additional withholding. c. The withholding tables vary based on filing status. d. Extra allowances can be claimed and reduce withholding. Itemized deductions reduce the withholding required by the taxpayer. c73f741a-e62b-4639-aa51-056bccd46bb4.doc. Page 2 of 9. 6. Which of the items is not correct regarding withholding? a. Employees who also have self-employment income can have additional amounts withheld to avoid B estimated tax payments. b. Employees cannot claim an allowance for a child unless they are entitled to claim the child as a dependent. c. Employees can claim exempt and avoid withholding. d. Married employees can choose to be withheld at the higher single rates. Additional allowances can be claimed for many purposes (e.g., large itemized deductions) in addition to personal and dependency exemptions. 7. Which of the following regarding the Form W-4 is incorrect? a. Determines an employee's income tax withholding. D b. Employees can claim more allowances than personal exemptions that will be claimed. c. Employees can specify additional amounts to be withheld each month. d. The form can only be adjusted at the beginning of year or start of employment. Employees may adjust the Form W-4 throughout the year. 8. Which of the following statements is true regarding excess Social Security contributions by an employer? a. Excess contributions are treated as additional income tax withholding payments. D b. A second employer can stop withholding once an employee's total contributions reach the Social Security wage base. c. The Treasury returns excess Social Security Withholding to employers. d. Excess contributions are treated as voluntary contributions to the Treasury. Excess payments are treated as additional voluntary contributions to the Treasury. Pages 5, 6, 7 and 8. Deductibility of compensation 9. Big Corp. pays Sue a salary of $100,000 in 2011. On 12-31-11, Big Corp. notifies Sue that her bonus is $20,000 for 2011, to be paid on January 31, 2012. The employer’s 2011 compensation deduction related to Sue is: a. $120,000 if Sue owns no stock of Big Corp. b. $120,000 if Sue is a 100% stockholder of Big. A 10. Corporation X, a calendar year accrual basis taxpayer, was short on cash in December, 2011, so it accrued [but did not pay] year-end bonuses of $20,000 to the President and 100% stockholder, and $10,000 to the Vice- president who owns no stock. The Bonuses were paid in February, 2012. How much does X corp. deduct? For 2011? For 2012? For 2011? For 2012? C a. $30,000 $0 b. $20,000 $10,000 c. $10,000 $20,000 d. $0 $20,000 11. A business owner takes a large salary from her very profitable corporation. If the IRS determines that the salary is unreasonably large and treats it as in substance a dividend, it will propose? a. Increase the gross income of owner b. Increase the gross income of corporation C c. Decrease the expense of the corporation d. Add a surtax to tax return of owner 12. The IRS has determined that the $500,000 salary paid by the very profitable Local Corp, to its president and major stockholder exceeded reasonable compensation of the president by $200,000. Which of the following will not be increased as a result of the adjustment likely to be proposed by the IRS? a. Corporate taxable income b. Corporate income tax C c. Individual taxable income c73f741a-e62b-4639-aa51-056bccd46bb4.doc. Page 3 of 9. Page 9. Equity Based Compensation 13. Which of the following is not a purpose of equity-based compensation? a. Provide risk and incentives to employees. D b. Motivate employees by aligning employee and employer incentives. c. Avoid compensation limits for executives. d. Provides a low or no cost form of compensation. Employers have to repurchase shares or dilute ownership (incurring opportunity costs) to provide equity- based compensation. Page 10. Stock Options 14. How is the bargain element for a stock option calculated? a. The difference between the strike price and the market price on the date of grant. C b. The difference between the market price on the exercise date and the market price on the date of grant. c. The difference between the market price on the exercise date and the strike price. d. The difference between the market price on the sale date and the strike price. The bargain element is simply the difference between the market price on the exercise date and the strike price. 15. Which of the following is true regarding stock options? a. A loss is realized when stock options lapse. B b. There is typically no tax effect on the grant date. c. Income recognized on the exercise date is greater for incentive stock options than nonqualified options. d. The bargain element on a nonqualified option is taxed to employees at capital gain rates. No tax effect is incurred by employees or employers on the grant date. Page 11, 12. Employee considerations – both NQSO and ISOs 16. Which of the following refers to the date stock options are awarded to an employee? a. Grant date. b. Exercise date. c. Lapse date. d. Vesting date. A The grant date is the date on which an employee receives the stock options. 17. Aharon exercises 10 stock options awarded several years ago. The following information pertains to the options: (1) [March 1, 2005] Company granted option that gives Aharon the right to buy 10 shares. (2) [March 1, 2005] Market price on the grant date was $7. (3) [March 1, 2005] Strike price is $10. (4) [March 1, 2012] Market price on the exercise date was $15. How much will it cost Aharon to purchase the options on the exercise date? a. $90. b. $500. c. $700. d. $1,000. D $1,000 (10 options x 10 shares x $10 exercise price). 18. Aharon exercises 10 stock options awarded several years ago. The following information pertains to the options: (1) [March 1, 2005] Company granted option that gives Aharon the right to buy 10 shares. (2) [March 1, 2005] Market price on the grant date was $7. (3) [March 1, 2005] Strike price is $10. (4) [March 1, 2012] Market price on the exercise date was $15. Assume these are not incentive options and all rights in the stock vested on March 1, 2012. How much income will Aharon recognize in 2012 from these transactions? a. $30 b. $50 c. $80 d. $150 B c73f741a-e62b-4639-aa51-056bccd46bb4.doc. Page 4 of 9. 19. Maren received 10 NQOs (each option gives her the right to purchase 10 shares of stock for $8 per share) at the time she started working the stock price was $6 per share. When the share price was $15 per share, she exercised all of her options. Eighteen months later she sold all of the shares for $20 per share. What is the amount of Maren's bargain element? a. $0. b. $700. c. $900. d. $1,500. B 10 shares x ($15 market price at exercise - $8 exercise price) 20. Maren began her position as CFO for Big Company on January 2, 2006. On January 2, 2008, She received (was granted) 10 NQOs (each option gives her the right to purchase 10 shares of stock for $8 per share). All rights will vest upon exercise of an option. On grant date, the stock price was $6 per share. On January 2, 2010, (when the share price was $15 per share), she exercised all of her options. On January 2, 2012, she sold all of the shares for $20 per share. How much gain will Maren recognize on the sale of the stock and how much tax will she pay assuming her marginal tax rate is 35 percent? a. $0 gain and $0 tax. c. $500 gain and $175 tax. B b. $500 gain and $75 tax. d. $1,200 gain and $180 tax. The gain realized is $500 (100 shares x $20) less basis (100 shares x $15 exercise price). The tax is calculated as follows: $500 x 15% (preferential rate). 21. Bad Brad received 20 NQOs (each option gives him the right to purchase 30 shares of stock for $10 per share) from his employer. At the time he started working the stock price was $11 per share. Now that the share price is $25 per share, he intends to exercise all of the options. Two years later Bad Brad sells the stock for $27 per share, what is Bad Brad's basis in his stock for purposes of calculating the gain or loss? a. $6,000 b. $9,000. c. $15,000. d. $16,200. C The basis is the $6,000 (600 shares x $10 strike price) cash paid and the $9,000 (600 shares x $15 bargain element) income recognized on the exercise—which is equal to the market price on the exercise date less the strike price. Page 13, 14. Employee and Employer considerations – ISOs Page 17, 18, 19. Restricted Stock –Employee and Employer considerations 22. Which of the following statements regarding restricted stock is false? a. Like stock options, restricted stock has to vest before it can be sold. B b. Like nonqualified stock options, the employee's income inclusion for restricted stock is the bargain element. c. Even if the value of restricted stock decreases from the price on the grant date, it retains some value to the employee. d. There is no effective tax planning elections for restricted stock. Employees are taxed on the fair market value of the restricted stock. 23. Tom recently received 2,000 shares of restricted stock from his employer, Independence Corporation, when the share price was $10 per share. Rick's restricted shares vested three years later when the market price was $14. Rick held the shares for a little more than a year and sold them when the market price was $20. What is the amount of Tom's income or loss on the vesting date? a. $0. b. $10,000. c. $20,000. d. $28,000. D 2,000 x $14 (market price on vesting date). c73f741a-e62b-4639-aa51-056bccd46bb4.doc. Page 5 of 9. 24. Tom recently received 2,000 shares of restricted stock from his employer, Independence Corporation, when the share price was $10 per share. Rick's restricted shares vested three years later when the market price was $14. Rick held the shares for a little more than a year and sold them when the market price was $12. What is the amount of Tom's income or loss on the sale? a. $0. b. $2,000 loss. c. $4,000 gain. d. $4,000 loss. D $4,000 loss is $24,000 (2,000 shares x $12 market value on sale date) of sales proceeds less $28,000 (2,000 shares x $14 market price on vesting date) basis. 25. Stevie recently received 1,000 shares of restricted stock from her employer, Nicks Corporation, when the share price was $8 per share. Stevie's restricted shares vested three years later when the market price was $11. Stevie held the shares for a little more than a year and sold them when the market price was $16. What is the amount of Stevie's ordinary income with respect to the restricted stock? a. $0. b. $5,000. c. $8,000. d. $11,000. D $11,000 (1,000 shares x $11 market price on vesting date). 26. Stevie recently received 1,000 shares of restricted stock from her employer, Nicks Corporation, when the share price was $8 per share. Stevie's restricted shares vested three years later when the market price was $11. Stevie held the shares for a little more than a year and sold them when the market price was $16. Assuming Stevie made a section 83(b) election, what is the amount of Stevie's ordinary income with respect to the restricted stock? a. $0. b. $5,000. c. $8,000. d. $11,000. C $8,000 (1,000 shares x $8 market price on grant date). 27. Which of the following pairs of items is not needed to calculate the after-tax proceeds for a same-day sale? a. Strike price and market price on exercise date. B b. Strike price and market price on grant date. c. Market price on sale date and market price on exercise date. d. Market price on sale date and marginal tax rate. The market price on grant date is not needed. 28. Which of the following is false regarding a section 83 (b) election? a. The election freezes the value of the employee's compensation at the grant date. D b. The election is an important tax planning tool if the stock is expected to increase in value. c. The election must be made within 30 days of the grant date. d. If an employee leaves before the vesting date any loss is limited to $3,000. Employees are not allowed to deduct a loss if restricted stock subject to a section 83(b) election is forfeited. Taxable Fringe Benefits 29. Which of the following is not an example of a taxable fringe benefit? a. $1,000,000 group term life insurance policy. c. Personal use of corporate jet. B b. $200 of employer provided parking. d. Automobile allowance. Employer provided parking is nontaxable up to $230 per month. 30. Bonnie's employer provides her with an annual dinner club membership costing $5,000. Her marginal tax rate is 25 percent. Her employer has a marginal tax rate of 35 percent. What is Bonnie's after-tax benefit? a. $0. b. $1,250. c. $3,750. d. $5,000. C The after-tax benefit is the $5,000 benefit less the $1,250 ($5,000 x 25 percent) of tax. c73f741a-e62b-4639-aa51-056bccd46bb4.doc. Page 6 of 9. Non-Taxable Fringe Benefits Page 26-Group-term life insurance, Health benefits, Meals and lodging 31. Tom is 33 years old. His employer pays the premiums for group term life insurance coverage of $40,000. The cost of Tom’s coverage to the company is $1,000. If the plan providing this coverage is nondiscriminatory and Tom is not a key employee, how much gross income does Tom report (rounded)? a. $29.00 b. $50.00 c. $300.00 d. $314.00 e. $0 E 32. Beth is 33 years old. Beth’s employer pays the premiums for group term life insurance coverage of $100,000. The cost of Beth’s coverage to the company is $1,000. If the plan providing this coverage is nondiscriminatory and Beth is not a key employee, how much gross income does Beth report (rounded)? a. $29.00 b. $48.00 c. $300.00 d. $314.00 e. $0 B 33. Grace's employer is now offering group-term life insurance. The company will provide each employee with $200,000 of group-term life insurance. It costs Grace's employer $700 to provide this amount of insurance to Grace each year. Assuming that Grace is 43 years old, use the table to determine the monthly premium that Grace must include in income as a result of receiving the group-term life benefit? a. $0. b. $15.00. c. $22.00. d. $58.33. B See Regulation. $200,000 policy less $50,000 exemption times 10 cents per month per thousand of coverage. 34. Which of the following is not an example of a nontaxable fringe benefit? a. Monthly employer provided transit benefit of $100. B b. Group-term life insurance policy providing $100,000 of coverage c. Employer provided parking of $100 per month. d. Qualified employee discounts. Only $50,000 of group-term life insurance qualifies as a nontaxable fringe benefit. 35. Rachel receives employer provided health insurance. The employers cost of the health insurance is $6,000 annually. What is her employer's after-tax cost of providing the health insurance, assuming that its marginal tax rate is 35 percent? a. $0 b. $3,900 c. $4,198 d. $6,000 B The after-tax cost is the $6,000 outflow less the $2,100 ($6,000 x 35 percent) of income tax benefit. 36. Lara, a single taxpayer with a 30 percent marginal tax rate, desires health insurance. The health insurance would cost Lara $5,000 to purchase if she pays for it herself (Lara's AGI is too high to receive any tax deduction for the insurance as a medical expense). Lara's employer has a 40 percent marginal tax rate. Ignoring payroll taxes, what is the maximum amount of before-tax salary Lara would give up to receive health insurance? a. $1,500. b. $5,000. c. $7,143. d. $8,333 C $5,000/(1 - .3). 37. Bill is the night manager at the Shady Arms motel. He is provided a room at the motel, free of charge, although he is not required to stay at the motel as a condition of employment. The fair rental value of this room was $4,400. Nix estimates that living elsewhere would have cost at least $5,200. Bill must report gross income of: a. $0 b. $800. c. $4,400 d. $5,200. C 38. Which of the following does not qualify as a "for the convenience of the employer" nontaxable fringe benefit? a. The fair market value of the rent of an apartment manager living on the premises. D b. An overtime meal provided to an employee while working late. c. A meal provided by a hospital to residents during their shift. d. A company picnic The value of a company picnic is a nontaxable fringe benefit, but it is not a "for the convenience of the employer" benefit. c73f741a-e62b-4639-aa51-056bccd46bb4.doc. Page 7 of 9. Page 27-Employee Education Assistance, Dependent Care benefits 39. Which of the following statements regarding employer provided educational benefits is true? a. All undergraduate tuition expenses can be excluded. C b. Only educational benefits from public universities can be excluded. c. Up to $5,250 in tuition benefits can be excluded. d. All graduate tuition expenses are included. An annual benefit of $5,250 can be excluded. 40.Ann earned a salary of $40,000 from Big Bank. Ann also received: (1) medical insurance costing the Big Bank $8,000 and (2) child care worth $4,000 for her 3-year-old child at the on-site Big Bank child care center. Ann was among the top executives in getting new business and received a check for $1,000 Myrtle Beach Golf Weekend, paid for by Big Bank. What is the amount of gross income that Ann will report for her work for Big Bank? a. $53,000 b. $45,000 c. $41,000 d. $40,000 C 41. Which of the following is false regarding dependent care expenses? a. Up to $5,000 of reimbursed expenses can qualify. B b. Employers may discriminate among employees. c. Dependent children under 13 qualify. d. Spouses who are physically or mentally unable to care for themselves qualify. Employers may not discriminate with respect to dependent care expenses. 42. Tasha receives reimbursement from her employer for dependent care expenses for up to $8,000. Tasha applies for and receives reimbursement of $6,000 for her 10 year old son. How much, if any, is includible in her income? a. $0. b. $1,000. c. $3,000. d. $6,000. B Employees may exclude up to $5,000 of dependent care expenses. Page 27 and 28. No additional cost service, Employee Discounts, Working condition fringe 43. Which of the following benefits cannot be excluded as a no additional cost service fringe benefit? a. Free tax return preparation from a client. A b. Complementary dry cleaning for employees at a laundry company. c. A car wash at an automobile dealership. d. Free local phone service for phone company employees. The service must be provided at no additional cost by the employer. 44. Which of the following is not a requirement of a "qualified employee discount"? a. The discount relates to goods or services of the employer. C b. The discount doesn't exceed 20 percent of fair market value. c. The discount can be elected up to five times annually. d. The employee price is not below employer's cost. There is no limitation on the number of times the employees can use the discount. 45. Francis works for a local fly fishing shop. The shop allows employees to purchase two fly rods per year at a discount. This year Francis purchased one rod. The rod normally retails for $300, purchased for $225, and sold to Francis for $250. What amount of the discount must be included in Francis' income? a. $0 b. $25 c. $50 d. Other A Because the discount was less than 20 percent, but above cost, there is no income inclusion. c73f741a-e62b-4639-aa51-056bccd46bb4.doc. Page 8 of 9. 46. Kevin is the financial manager of Levingston BMW. The shop allows employees to purchase up to two vehicles at a discount. This year Kevin purchased a 530 model and a new M3. Model FMV Dealer Cost Employee Price 530 $63,000 $50,000 $54,000 M3 $65,000 $60,000 $57,000 What amount must Kevin include in income? a. $3,000 b. $17,000 c. $18,000 d. $25,000 A Because the M3 is sold below dealer cost, Kevin must take $3,000 into income. 47. Big Bank owns several condos in Charlotte that are used by out-of-state employees who come to Charlotte for training or temporary work assignments. John, who was recently transferred permanently to Charlotte, accepted Big Bank’s offer to sell one of the condos to John. The bank had paid $200,000 for the condo, which had a current appraised value of $300,000. John bought the condo from Big Bank for $220,000. How much income does John report on this transaction? a. $20,000 b. $60,000. c. $80,000 d. $100,000 C 48. Big Utility requires executives to travel to power generating plants in the state on a regular basis. Each executive is provided a company auto. The auto is only used for company business travel or transportation. Sue’s company auto is leased by Big Utility for $5,000 per year and the company spends $4,000 on fuel and operating costs. If Sue were to lease the same auto, she would have to incur lease payments of $6,000 and her fuel would cost $500 more at retail stores. How much income is reported by Sue for the auto? a. $0 b. $5,000. c. $9,000 d. $10,500 A 49. Harry is a CPA employed as a manager by a regional accounting firm. The firm pays Harry's dues of $200 to professional organizations and pays $135 monthly ($1,620 per year) for his personal parking place at the office. How much income is reported by Harry for these items? a. $0 b. $200. c. $1,620 d. $1,820 A 50. All of the following fringe benefits paid for by the employer may be excluded from an employee's gross income except a. Membership fees in professional organizations. D b. Recreational facilities c. Unused airline seats for airline employees where the employee is required to fly "standby." d. Discounts on services up to 50 percent. 51. Betsy completed her MACC in Dec. 2011. On 1-2-12 she began work at a salary of $50,000 per year in the tax department of a CPA firm. The firm gave her a reimbursement of $1,000 for a CPA Review course she took, and $250 for registration costs for a CPE course on New Federal Tax Developments. What is her 2012 AGI? a. $50,000 b. $51,000 c. $51,250 d. $50,250 B Page 29. Diminimis, Transportation, Moving 52. Which of the following is a fringe benefit that employers can discriminate among employees? a. No additional cost service. C b. Qualified employee discount. c. Qualified transportation fringe. d. Employee educational assistance. See Exhibit 12-13. c73f741a-e62b-4639-aa51-056bccd46bb4.doc. Page 9 of 9. Page 30. Cafeteria Plan, Flexible Spending Account 53. Susan earns a salary of $40,000 per year. The employer provides hospitalization insurance for employees, but not dental insurance. Under the company’s qualified cafeteria plan, Susan was entitled to choose up to $4,000 of fringe benefits not otherwise covered by the employer. She chose to receive a $3,000 dental insurance policy and received a check for the $1,000 balance in her $4,000 allowance. What is her adjusted gross income? a. $40,000 b. $41,000 c. $43,000 d. $54,000 B 54. Which of the following statements concerning cafeteria plans is true? a. Allows employees to choose from a menu of fringe benefits or to choose cash. D b. Most of the menu choices are nontaxable fringe benefits. c. Any cash elected is treated at taxable compensation. d. All of the above are true statements. See discussion in text. 55. Tanya's employer offers a cafeteria plan that allows employees to choose among a number of benefits. Each employee is allowed $6,000 in benefits. For 2009, Tanya selected $3,000 of parking, $2,000 in 401(k) contributions, and $1,000 of cash. How much must Tanya include in taxable income? a. $0. b. $1,000. c. $1,240. d. $4,000. C $1,240 is includable: $240 of parking benefits [$3,000 - ($230 excludable amount x 12)] and $1,000 of cash.
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