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.
