Critical Thinking Problems
1. Buster was driving behind an armored truck when suddenly the rear door flew open and a bag containing 2 million dollars landed on the hood of his car. Buster grabbed the bag and drove off, certain that no one had seen him, since it was late at night on a lonely road. He brags to you that he has received a tax-free bonus from heaven. Is Buster correct in assuming this money is not taxable? (Be sure to give the concepts that help you decide.)
2. Gretchen, 22, is a single individual with no dependents. She recently graduated from college and has received job offers from two firms. Gretchen likes both companies equally well and has decided to choose between them based on which company offers more. Details of each job offer are below.
Company A - annual salary of $50,000; employer provided health and accident insurance (employer cost of $2,400); group term life insurance coverage at twice the annual salary; employer provided day-care facility (employer cost per dependent is $150 per month); and covered parking (value is $4,000 per year).
Company B - annual salary of $45,000, a cafeteria plan under which Gretchen may choose benefits of up to 10% of her annual salary or take a cash equivalent. In addition, the company has a flexible benefits plan in which employees may participate by setting aside up to 10% of annual salary per year for payment of unreimbursed medical expense.
Analyze the tax effects of the two job offers and then explain how each will affect Gretchen. Calculate the total after tax income (taxable and excluded) Gretchen can expect from each. Assume she has no other income and will use the standard deduction.
For each of the following independent situations, state which concept(s) is (are) responsible for the treatment and EXPLAIN how each concept is applied.
3. 1. Alabama Construction, Inc., an accrual basis taxpayer, billed a client in December 2014 $12,000 for services performed. In March 2015, the corporation received a check from the client for $10,000. Included with the check was a letter stating that some of the services were not performed correctly. After investigating the matter, Alabama Construction agreed that the customer was correct. Alabama Construction must include $12,000 in its 2014 income, but will take a deduction of $2,000 in 2015.
4. 2. Layton Company purchased machinery in 2010 at a cost of $40,000. Between 2010 and 2014, Layton properly deducted $14,000 for depreciation expense on the machinery. In 2014, the machinery is sold for $20,000. Layton reports a loss of $6,000 from the sale of the machinery.
5. 3. Penn Corporation, an accrual basis taxpayer, provides lawn equipment for rent to others. In May of 2014, Penn receives $4,000 from the rental of lawn equipment on a 2-year contract. Penn must recognize the $4,000 income from the contract in 2014.
6. 4. Reno, a cash basis taxpayer, receives $1,800 from Conner in December 2014. The $1,800 was for payment of the first and last month's rent ($700 per month) and a $400 damage deposit on a building Conner rented from Reno. Randall must include $1,400 in his 2014 taxable income.
7. 5. Nebraska Corporation receives a $12,000 bill for legal fees from its attorney in December 2014. The corporation paid the bill promptly and deducted the $12,000 as a legal expense in 2014. During the audit of its financial statements, the auditor determines that the attorney had double billed the corporation for $3,000 of expenses. The attorney agrees with the auditor and sends Nebraska a check for $3,000 in April. Nebraska must recognize $3,000 of income in 2015.