Document Sample
CHAPTER 1 Powered By Docstoc
					                                         CHAPTER 4

                                      GROSS INCOME

                         SOLUTIONS TO PROBLEM MATERIALS

1.   Because Cecil does not know how much he will receive from the sale of automobile parts,
     and it is impractical to determine the cost of individual automobile parts, he could reason
     that all sales proceeds are a recovery of capital until he has received his cost of $250,
     and all subsequent proceeds are included in gross income. The IRS may argue that Cecil
     should allocate his cost of the car among the various parts, which may be impractical.
     pp. 4-3 to 4-7

2.   a.   The overcharge to the customer created a liability equal to the amount of the
          overcharge. Therefore, the taxpayer did not experience an increase in wealth from
          an economic point of view. For tax purposes, the taxpayer would report gross
          income in 2008 and a deduction in 2009.

     b.   From an economist’s point of view, the taxpayer suffered a $1,000 loss from the
          decline in value in the year of purchase, and then experienced a $3,500 ($6,500 –
          $3,000) gain in the year the stock was sold. For tax purposes, the taxpayer realized
          a $2,500 ($6,500 – $4,000) gain in the year the stock was sold. The loss was not
          recognized in the year of purchase for tax purposes because the loss was not
          realized in that year.
     c.   According to the economist, the carpenter should recognize income in the year the
          improvements were made, based on the increase in value of the property improved.
          Thus, the carpenter should recognize $26,000 ($140,000 – $100,000 – $14,000)
          when the improvements were made and no income in the year of sale. The
          economist may reason that the carpenter made $20,000 from the imputed value of
          his services and $6,000 from the sale of the property. Which of these options the
          economist selects depends on the fair market value of the property at the end of the
          tax year in which the improvements were made. For tax purposes, no income was
          realized until the property was sold, and the $26,000 was gain from the sale of the

     d.   The discount the shareholder received on the purchase of the property of $5,000
          ($15,000 – $10,000) is income (a constructive dividend) for tax purposes. From an
          economic perspective, the shareholder and his corporation may not be treated as
          separate entities and thus the shareholder was receiving what he already owned
          and was retaining his $10,000 cash received by his corporation. So there is no

     pp. 4-4 to 4-6

3.   By paying the carpenter in cash, with the knowledge the cash will not be reported, it
     would seem that you become party to the carpenter’s tax fraud. You appear to have no
     legal liability, but it seems apparent that you would be a participant in that you benefited
     from the carpenter’s scheme. The carpenter’s comments that suggest that he feels he is

      within the bounds of the law and ethics are transparent. When the income is earned (i.e.,
      after regular working hours) has nothing to do with measuring the taxpayer’s ability to
      pay. Therefore, it would seem that you should pay the $700 by check. Alternatively, you
      may want to pay with a check, but negotiate to have the price reduced to less than $700.
      If you pay in cash, you should obtain a receipt from the carpenter as proof of payment.
      pp. 4-4 to 4-6
                                       Gross Income                                        4-3

4.   Reno was favored, because he was not taxed on the value of his work on the automobile.
     He spent $3,400 of his money on the automobile, which presumably was from earning
     $4,533 [$3,400 ÷ (1 – .25)] and paying tax of $1,133. The value added by his work of
     $3,600 ($7,000 – $2,000 – $1,400) on the automobile was not subject to income tax.
     Therefore, Reno paid only $1,133 to have the earnings needed to acquire an automobile
     whose value was a $7,000 automobile. For Tom to acquire a similar car, he was required
     to earn taxable income of $9,333 [$7,000 (1 – .25)] and pay income tax of $2,333
     ($9,333 – $7,000). pp. 4-3 and 4-4

5.   a.   The income should be reported in 2009. In 2008, Jared has not received anything of

     b.   The significance of when the income is recognized by Jared relates to (1) the time
          value of money—if the tax is deferred, the present value of the tax decreases; and
          (2) the marginal tax rates—the taxpayer may be subject to different rates between
          years because of changes in the tax law, changes in his or her taxable income,
          changes in the taxpayer’s filing status, and changes in the entity status.
     pp. 4-7 to 4-9

6.   a.   Kevin’s gross income:

          Salary                                $ 80,000
          2007 bonus paid in 2008                 12,000
          2008 bonus                              15,000

          The 2008 bonus of $15,000 is constructively received in 2008 because it was made
          available to him in 2008. The 2007 bonus was not constructively received in 2007
          because the employer’s computer problems meant that the bonus was not available
          to Kevin in 2007.

     b.   December 27, 2008
          Tax File Memorandum
          From: John Jones
          Subject: Kevin’s Bonus for the Year 2009
          Kevin is a cash basis taxpayer whose marginal tax bracket is projected to be greater
          in 2009 than in 2010 when he retires. Kevin should arrange with his employer at the
          beginning of 2009 that his bonus for that year will not be paid until 2010 when he is
          projected to be in a lower tax bracket. If the agreement is made with the employer
          before the payments are earned, there will be no constructive receipt problem.
     p. 4-11
7.   The taxable bond and reinvested earnings will accumulate at an after-tax rate of 4.32%
     [(1 – .28) × .06] to equal $12,355 at the end of 5 years [$10,000 × (1.0432)5 = $10,000 ×
     1.2355 = $12,355].

     The income from the Series EE bond will not be taxed until maturity in five years, and the
     after-tax value will be $12,210 [$13,070 – .28($13,070 – $10,000)].

     Thus, the after-tax proceeds from the land must exceed $12,355.

      Because the gain on the land will be taxed as long-term capital gain, the sales proceeds
      less 15% of the appreciation must exceed $12,355.
      $10,000 + (1 –.15)(X – $10,000) = $12,356
      $10,000 + .85x – $8,500 = $12,356
      85x = $10,856
       x = $12,772.
      Thus, the land must increase in value by at least $2,772 to yield a greater after-tax return
      than the investment in either of the bonds.

      It should be noted if the land increases in value to $12,772, it will have a smaller before-
      tax value than the Series EE bond, but the land will have a greater after-tax value. The
      greater after-tax value of the land results from the lower tax rate. Also, the taxable
      corporate bond has a greater before-tax rate of return than with the Series EE bond, 6%,
      but a lesser after-tax return because income from the bond is taxed each year.

      Thus, the tax rate and the timing of the tax payments are determinants of the after-tax
      rate of return from an investment.

      pp. 4-3 to 4-5, 4-28, and 4-29
 8.   a.   Olga has $300 of interest income and a recognized gain of $500 ($10,800 – $300 –

      b.   Olga does not recognize income from using the stock as collateral for the debt. Her
           assets (cash) and liabilities increased by the same amount, and she continued to
           own the stock. Thus, there is no realized gain.

      c.   Mere increases in the value of an asset are not included in gross income. Note the
           attorney’s fee should be added to Olga’s cost of the property in calculating her basis
           for the vacant lot.

      pp. 4-4 to 4-6

 9.   a.   Gross income using cash method:
           Cash collections from customers                                 $150,000
           Under the cash method, income is recognized when cash or its equivalent is
           actually or constructively received, regardless of when it was actually earned.
           Neither gross income nor taxable income is affected by the uncollectible accounts.
           Income was not recognized when the income was earned. The deposit is not Al’s
           money. Rather, Al is the agent holding the money on behalf of the client.
      b.   Gross income using accrual method:
           Cash collections                                                $150,000
           Less: Beginning accounts receivable                               (25,000)
           Plus: Ending accounts receivable                                   60,000
      c.   Al should use the cash method so that he will not have to pay income taxes on
           uncollected accounts receivable.
      pp. 4-7 to 4-10
Gross Income   4-5

10.   a.   Accrual basis gross receipts
           Cash received                                                  $1,500,000
           Less: beginning accounts receivable                              (200,000)
           Less: bank loan                                                  (100,000)
           Add: ending accounts receivable                                   400,000
           Gross receipts                                                 $1,600,000

      b.   Gross income
           Gross receipts                                                 $1,600,000
           Cost of goods sold:
             Purchases                                                    $1,200,000
             Beginning inventory                                             100,000
             Ending inventory                                               (300,000)
           Cost of goods sold                                            ($1,000,000)
           Gross income                                                   $ 600,000

      pp. 4-7 to 4-10

11.   TO:               Susan Apple
      FROM:             Bill Swan
      SUBJECT:          Dispute Over Recording of Income by Color Paint Shop, Inc.
      DATE:             October 1, 2009

      I am responding to the questions you raised regarding the timing of the reporting of
      income by Color Paint Shop, Inc. with respect to the dispute concerning the painting
      of Samuel Customer’s car. The key issue is whether Color (1) should accrue the $1,000
      of income in 2008 and take a $200 loss deduction in 2009 (the IRS view), (2) report the
      $800 in 2008 or (3) delay recording the $800 income until 2009 (Color’s preferred
      An accrual basis taxpayer is required to recognize income when (1) all the events have
      occurred to establish the taxpayer’s right to receive the income, and (2) the amount of the
      income can be determined with reasonable accuracy. In Color’s case, it does not appear
      that all the events to fix the rights to the income had occurred in 2008. The insurance
      company had not approved the work by the end of the year. One could reason that
      Samuel’s approval of the work is the critical event that fixes Color’s right to receive the
      income, because the insurance company is merely the paying agent of the customer.
      However, even with this conclusion that the all-events test had been satisfied by the end
      of 2008, the amount of the income cannot be determined with reasonable accuracy
      because the insurance company may renegotiate the price. Thus, the transaction should
      be held open and no income should be reported until 2009. The amount of income Color
      should report in 2009 is $800.

      pp. 4-8 and 4-10
                                          Gross Income                                           4-7

12.   Evidently this is not an appropriate time to tax as evidenced by a recent tax law change.
      Normally, debt forgiveness results in taxable income but under the Mortgage Forgiveness
      Debt Relief Act of 2007, enacted December 20, 2007, taxpayers may exclude debt
      forgiven on their principal residence if the balance of their loan was less than $2 million
      ($1 million for a married person filing a separate return). The new law applies to debt
      forgiven in 2007, 2008 or 2009. Debt reduced through mortgage restructuring, as well as
      mortgage debt forgiven in connection with a foreclosure, may qualify for this relief. p. 4-26

13.   CPA’s advise their clients to use the accrual method for financial reporting not only
      because the CPA believes that method provides a better measure of income, but also
      because Generally Accepted Accounting Principles require that financial statements must
      be prepared using the accrual method. However, the CPA will often advise the client to
      use the cash method for tax purposes, where that method is permissible, because the
      cash method allows the taxpayer to defer income from accounts receivable and provides
      more control over the period in which expenses are deducted. This is a matter of helping
      the client to minimize the present value of the tax liability, and is not hypocritical. pp. 4-8
      and 4-9

14.   a.   The $1,500 advance payment can be deferred until 2008 because the property was
           not delivered until 2008 and the revenue was not recognized for financial accounting
           purposes until 2008.
      b.   Gross income of $175 ($25 per month × 7 months) from the 12-month contract must
           be reported in 2008. The prepaid income qualifies for deferral under Revenue
           Procedure 2004-34. The portion of the advance payment that relates to services
           performed in the tax year of receipt is included in gross income in the tax year of
           receipt. The portion of the advance payment that relates to services to be performed
           after the tax year of receipt ($300 – $175 = $125) is included in gross income in the
           tax year following the tax year of receipt of the advance payments.
           For the 24-month contract, the amount included in gross income in 2008 is $25 ($25
           per month × 1 month) and in 2009 is $575 ($600 – $25).

      c.   The company must include $1,200 in gross receipts and can deduct the cost of the
           appliance, $750, in arriving at gross income of $450. The fair market value of the
           note is not relevant for purposes of determining the accrual method taxpayer’s gross

      pp. 4-12 and 4-13

15.   The medical doctor is taking advantage of the limitations on the application of the
      constructive receipt doctrine. Since he has neither actual receipt nor constructive receipt,
      he can delay including the November and December unfiled insurance claims in gross
      income until payment is received in the following year. The doctor thus can be comforted
      with the thought that this income will be subject to tax when his marginal tax rate will be
      lower in the subsequent year.
      pp. 4-8, 4-9, and 4-11

16.                          Smith, Raabe, and Maloney, CPAs
                                   5191 Natorp Boulevard
                                     Mason, OH 45040

      October 1, 2008

      Ms. Amanda Sims
      Managing Partner
      Aspen Associates
      100 James Tower
      Denver, CO 80208
      Dear Ms. Sims:
      I am responding to your suggestion that Aspen Associates should change to the accrual
      method of accounting for tax purposes as a means of reducing accounting fees. Under
      the accrual method of accounting, receivables must be recognized as income as the
      services are performed. This is to be contrasted with the cash method of accounting
      where no income is recognized until payment is received.
      Each year, under the accrual method, accelerated tax payments would occur so long as
      the billing and collection pattern remains the same. Therefore, the partners will pay tax on
      an additional $75,000 in the first year’s income, and those payments will not be recovered
      until the company ceases its operations. Assuming the partners are in the 35%
      (combined State and Federal) marginal tax bracket, the deferred taxes under the cash
      method are $26,250 (.35 × $75,000). If the partners earn a 2.29% ($600 ÷ $26,250)
      return, or greater, on the deferred taxes, the additional accounting fees will be recovered.
      Therefore, I recommend that you continue to use the cash method.

      Tara Kelly, CPA
      Tax Partner
      pp. 4-7 to 4-9
17.   a.   Amur dividends (Note 1)                                         $55,000
           Blaze dividends (Note 2)                                         25,000
           Grape dividends                                                  12,000
           Total dividend income                                           $92,000

      Note 1: Even though Amur is a foreign corporation, the dividend is a qualified dividend
              because its stock is traded on an established U.S. securities market.

      Note 2: The dividend paid by Blaze is not a qualified dividend because the holding period
              requirement is not satisfied (i.e., must be held more than 60 days during the
              120-day period beginning 60 days before the ex-dividend date).
                                         Gross Income                                          4-9

            Qualified dividends
            Amur dividend                                                          $55,000
            Grape dividend                                                          12,000
            Applicable rate                                                          × 15%
            Tax on qualified dividends                                             $10,050
            Non-qualifying dividends
            Blaze dividend                                                         $25,000
            Applicable rate                                                         × 35%
            Tax on non-qualified dividends                                          $ 8,750
      b.   The daughter is in the 10% marginal tax bracket. She has $1,000 of qualified
           dividends which are eligible for the alternative tax rate of 0% in 2008 (rather than the
           usual 15%). So the daughter’s tax liability on the dividends is $0 ($1,000 × 0%).
       pp. 4-15 and 4-16

18.   a.   Bethany’s interest income for this year is $343 ($4,291 × 8%). The bond has original
           issue discount of $15,709 ($20,000 – $4,291), which must be amortized over the life
           of the bond using the effective interest method.
      b.   Bethany’s basis for the bond on December of this year is $4,634 ($4,291 + $343).

      c.   The interest income will be greater in 10 years than in this year because the interest
           is compounding. The interest income recognized each year is added to the original
           cost of the bond and the 8% interest rate is applied to the cumulative investment.

      pp. 4-11 and 4-12

19.   The following issues are suggested from the facts presented.

           Is the corporation required to impute interest income on the loan to Brad?

           Is Brad required to recognize income from the loan proceeds?

           Is Brad required to recognize income in respect to the favorable interest rate?

           Is the loan made to Brad in his capacity as a shareholder or as an employee?

           Is the loan subject to the original issue discount rules?

      pp. 4-11 and 4-18 to 4-20

20.                                                                             Income
        Loan from employer
            Compensation ($62,000)(.07)(1/2) =                                  $2,170*
        Loans to others
            To controlled corporation ($31,000)(.07)(1/2) =                     1,085**
            To Tab (exempt under $100,000 exception)                               –0–
        Certificates of deposit
                   One-year certificate (not subject to OID rules)                  –0–
                   Two-year certificate ($6,000)(.0625)(1/2)                        188

       *Ridge also has $2,170 of interest expense which may be deductible as investment
       interest (to the extent the loan proceeds were used for investment purposes).
       **Treated as an additional investment by Ridge and added to his cost of the stock.

       pp. 4-11 and 4-18 to 4-20
21.    a.   This loan is a gift loan between individuals that is eligible for the $100,000
            exception. Although Mike’s sister has $900 of investment income, interest is not
            imputed under this exception if the borrower’s net investment income is not greater
            than $1,000. So the imputed amount is $0.

       b.   This loan is an employer-employee loan for not greater than $10,000. Sam did not
            use the funds to buy investments and there appears to be no tax avoidance motive.
            Thus, no interest is imputed.
       c.   Interest is imputed on this loan. The $100,000 exception is not available on
            corporation-shareholder loans. The imputed interest would be calculated as follows:

                    $25,000 × (5.0% – 4%) × 1/2 = $125
       d.   The loan from Kait to Jake is classified as a gift loan between individuals that is
            eligible for the $100,000 exception. So the imputed interest income for the six
            months is calculated as follows:

                    $60,000 × 5% × 1/2 = $1,500

       pp. 4-18 to 4-20

22.    a.   The employer-employee loan would be eligible for the $10,000 exemption through
            June 30, 2008. However, in July 2009, the total outstanding loans exceed $10,000.
            The $100,000 exemption does not apply to these loans. Therefore, interest is
            imputed on the $12,000 amount of the loans for the period July through December
            2009. Vito, Inc. has interest income and Vito has compensation income of $480
            [.08($12,000 × 6/12)]. Vito also has interest expense of $480 and Vito, Inc. has
            compensation expense of the same amount. Note that employer-employee loans
            are not eligible for the $100,000 exemption.

       b.   A corporation-shareholder loan is not eligible for the $100,000 exemption and
            usually does not qualify for the $10,000 exemption (i.e., cannot satisfy the
            requirement that tax avoidance not be a principal purpose of the loan). Therefore,
                          Gross Income                                   4-11

for 2008 and 2009, the corporation has interest income and dividends paid (not
deductible) as follows:

            2008       ($8,000 × 8% × 6/12)                                    $320
            2009       ($8,320 × 8% × 6/12)                      $333
                       ($8,320 + $333 + $4,000)(.08)(6/12)        506         $839
            Vito has dividend income and interest expense of equal amounts.

       p. 4-21

23.    a.   Lemon Furniture must include $1,000 in gross income as the recovery of a prior
            deduction which produced a tax benefit.

       b.   Marvin must include $4,000 of the refund in his gross income for 2008 because he
            received a tax benefit for the deduction in 2007. The other $200 of the refund is not
            included in his gross income because it did not produce a tax benefit.

       c.   Barb must include $5,000 in her 2008 gross income, the amount of the reduction in
            taxable income from the medical expenses paid in 2007. The remainder of the
            amount received can be excluded as resulting from a personal physical injury.

       p. 4-21
24.    Hazel must include all of the items in gross income, except the interest received of $900
       on Augusta County bonds. The patronage dividend is included in gross income under the
       tax benefit rule because the dividend is a recovery of costs deducted in a prior year. All
       other items are simply gross income not otherwise excluded. Therefore, Hazel must
       include in gross income $1,050 ($600 + $300 + $150). pp. 4-21 and 4-22
25.    Clients who purchase the tax-exempt bonds should be in the 35% marginal tax bracket or
                              (1 - x)(.066) = .044
                              = .066 – .066X = .044
                              = .066X = .022
                              X = .33
       The break-even is a 33% marginal tax rate. Therefore, only those taxpayers in the 33%
       and 35% brackets should invest in the tax-exempt funds. p. 4-22
26.    The State of Virginia bonds are the better investment. The after-tax yield on the U.S.
       Government bonds is 3.64% [(1 – .35)(.056)], while the tax-exempt Virginia bonds yield
       4%. pp. 4-21 and 4-22
27.    a.   The life insurance proceeds of $50,000 were paid to the beneficiary as the result of
            the death of the insured and, therefore, are excludable from the gross income of
            Monty’s wife.
       b.   The proceeds of $500,000 are paid to the beneficiary upon the death of the insured.
            Therefore, Cardinal can exclude the insurance proceeds from its gross income.
       c.   The creditor received the insurance proceeds in an exchange for consideration.
            Therefore, the proceeds are taxable. However, if the creditor has already included
            the amount receivable from Barbara in gross income, the creditor will have no
            additional income to recognize.
                    Gross Income   4-13

pp. 4-24 and 4-25

28.    The after-tax cost of hiring a president is $120,000 [(1 – .40) ($200,000)]. The after-tax
       loss of income is $180,000 [(1 – .40) ($300,000)]. Because the life insurance proceeds
       are tax-exempt, the company will need only $300,000 of insurance to compensate for the
       loss. Thus, it appears that Egret needs to purchase only a $300,000 policy rather than a
       $500,000 policy. pp. 4-24 and 4-25

29.    a.   Fay is the beneficiary of the life insurance policy and can exclude the proceeds of
            $1.75 million from her gross income.
       b.   The $20,000 of interest earned on the life insurance proceeds left with the insurance
            company is included in Fay’s gross income.

       c.   Fay did not recognize a gain on the bargain purchase. Fay simply got a good price
            on the purchase under an arm’s length contract.

       pp. 4-23 and 4-24
30.    Hawk needs to identify and resolve the following issues.

            Did the mortgage holder sell the property to Hawk?

            Is Hawk insolvent or undergoing bankruptcy proceedings?

            If Hawk must recognize income from the debt cancellation, does it have losses to

            May Hawk reduce the basis of the asset rather than recognizing income?
       pp. 4-25 to 4-27

31.    a.   Olivia has the following results:
            LTCG (land)                                                                  $4,000
            STCL (IBM)                                                                   (1,000)
            STCG (boat and trailer)                                                       2,000
            Loss on camper (nondeductible)                                                  –0–
            Thus, she has a net LTCG of $4,000 and a net STCG of $1,000. Her tax is $930
            [($4,000  15%) + ($1,000  33%)].
       b.   $150 [($4,000  0%) + ($1,000  15%)].
       c.   $350 [($4,000  5%) + ($1,000  15%)].

       pp. 4-28 and 4-29
32.    a.   Short-term
            Gains                                                                          -0-
            Losses                                                                    (14,000)
            Net short-term capital loss                                             $ (14,000)


            Gains ($5,000 +$3,000)                                                    $ 8,000
            Losses                                                                        (-0-)
            Net long-term capital gain                                                 $ 8,000
Gross Income   4-15

            So Andy has a net capital loss of $6,000 ($8,000 - $14,000). Of this amount,
            $3,000 can be offset against ordinary income. The balance of $3,000 ($6,000-
            $3,000) can be carried forward to the following tax year.
       b.   The answer is the same as in (a).
       c.   A C corporation cannot offset capital losses against ordinary income. So the
            C corporation can carry the $6,000 net capital loss back 3 years and forward
            5 years.
       pp. 4-28 and 4-29
                                              a.                                 b.
                                           California                           Texas
                                 Doug                 Liz             Doug                Liz
             Salary             $48,000             $48,000          $48,000            $48,000
             Rent                                     8,000            4,000              4,000
             Dividends             1,900                                 950                950
             Interest              1,200             1,200             1,200              1,200
                                 $51,100           $57,200           $54,150            $54,150

       Under Texas law, the rents and dividends belong to the community even though this
       income is derived from separate property. Under California law, the income is community
       or separate depending on the state law classification of the underlying assets. In this
       case, the interest is community income because the savings account was funded with
       community property. Digging Deeper 1
34.    a.   The controversies over valuation would be numerous and would make it difficult to
            determine an annual income. Also, taxpayers would be required to pay the tax
            regardless of whether the taxpayer has the cash with which to do so (i.e., increase
            in value may be for an illiquid asset).
       b.   This is our present tax system and it prevails because it avoids the disadvantages of
            taxing changes in value, as discussed in a., above. The disadvantage, at least from
            the revenue collection perspective, of deferring recognition of the income until
            realization occurs is that the taxpayer has the choice as to when the economic
            income will become taxable income. Also, the present system taxes more heavily,
            from a timing perspective, assets that pay annual returns (e.g., interest, dividends,
            rents) than it taxes assets that merely appreciate from year to year (e.g., raw land).
       c.   Taxing on an annual basis the changes in values of publicly traded property only
            would create a bias against ownership of that type of property. In addition, there
            would be definitional problems with the term ‘‘publicly traded.”
       pp. 4-4 to 4-7

35.    The tax exemption on state (and local) bonds benefits the state and local governments,
       but also benefits the wealthy and thus reduces the progressivity in the tax system. An
       alternative means of benefiting the state and local governments, without creating a tax
       haven for the wealthy, would be to eliminate the exception and make a cash payment to
       the states and localities to defray the higher interest they must pay on taxable obligations.
       To date, this alternative approach has not been accepted and implemented. pp. 4-21 and
                                        Gross Income                                   4-17

1.   Solution will vary for each student.

2.   Solution will vary for each student.


1.                             Smith, Raabe, and Maloney, CPAs
                                    5191 Natorp Boulevard
                                       Mason, OH 45040
     December 29, 2008
     President, Tranquility Funeral Home
     400 Rock Street
     Memphis, Tennessee 38152

     Dear Sir:

     You asked me to address the question of when the income from pre-need funeral
     contracts should be included in gross income. Based on my research, I have concluded
     that the amounts collected are customer deposits, rather than the receipt of prepaid
     income. Therefore, the prepaid amounts are not included in gross income until the
     services are performed by Tranquility.
     In a case involving a situation much the same as yours, Perry Funeral Home, Inc. (86
     TCM 713, T.C. Memo. 2003-340), the Tax Court concluded that the prepayments were
     refundable deposits under the control of the customer, and therefore were not prepaid
     income. The payments were not prepaid income because the customer was not required
     to use the service – the customer could demand a refund anytime prior to the time the
     goods and services were provided. The Tax Court cites as authority Comm. v.
     Indianapolis Power & Light Co. [65 AFTR2d 90-394, 110 S.Ct. 589, 493 U.S. 203
     (1990)], which held that refundable utility deposits were not prepaid income.
     Please call me if you have any further questions.
     John J. Jones, CPA
2.   In Technical Advice Memorandum 9735002 (May 5, 1997), the IRS noted that it may be
     consistent with the purpose of § 7872 to apply that provision to loans to membership
     organizations, such as in the taxpayer’s situation. However, the present Regulations do
     not. Therefore, the members of the Cheyenne Golf and Tennis Club will not be required
     to impute interest income on their deposits.

3.   In Revenue Ruling 76-96, 1976-1 C.B. 23, the IRS announced that manufacturers’
     rebates are considered an adjustment to the cost of the automobile rather than included
     in gross income. So Paul should not include the $1,500 in his gross income.

 4.    The Internet Activity research problems require that the student access various sites on
       the Internet. Thus, each student’s solution likely will vary from that of the others.

       You should determine the skill and experience levels of the students before making the
       assignment, coaching them where necessary so as to broaden the scope of the exercise
       to the entire available electronic world.
       Make certain that you encourage students to explore all parts of the World Wide Web in
       this process, including the key tax sites, but also information found through the websites
       of newspapers, magazines, businesses, tax professionals, government agencies, political
       outlets, and so on. They should work with Internet resources other than the Web as well,
       including newsgroups and other interest-oriented lists.

       Build interaction into the exercise wherever possible, asking the student to send and
       receive e-mail in a professional and responsible manner.

 5.    See the Internet Activity comment above.
 6.    See the Internet Activity comment above.

 7.    See the Internet Activity comment above.
Gross Income   4-19


Shared By: