Question

Claim of Right Doctrine Examples:

1. Clara rented her garage apartment to Jared and collected $450, the first-month’s rent, in advance. She also collected $500 as a security deposit that she will return to Jared if he doesn’t damage the apartment. How much of the $950 is included in Clara’s gross income?

2. Shannon signs a $100,000 contract to develop a plan for integrating the computer operations of State University in December. Under the contract, she receives a $30,000 cash advance against future payments on the contract upon signing the contract. The contract stipulates that if Shannon does not produce an acceptable plan, she must repay any portion of the advance not earned to date. Does Shannon have any income from the receipt of the advance? When?

3. a. Tom, a contractor, was paid $20,000 in May for adding a screened porch onto the house of a customer. In November,         certain spots in the porch began leaking. The customer threatened to sue and requested $5,000 of         the $20,000 cost be          returned to him due to the leaking. None was returned to the customer in 2020. How much gross income must Tom            report in the current year, 2020?

      b. The dispute between Tom and his customer was settled in court in 2021, the following year. The court required Tom to          pay $3,000 to the customer for the water leakage problem. When should Tom report the $3,000 deduction? In 2020 or in       the year of settlement, 2021?

Fixed Annuity Example:

      Renee purchased a 10-year annuity for $4,000. It pays her $100 per month, and she received $1,200 from the annuity during the year. How much of the $1,200 is included in gross income?

      Expected return/value of the annuity =

      Exclusion % =             Cost_____    

                              Exp. Return/Value

      Excluded Income =

      Gross income =

Life Annuity Examples:

1.    George, age 68, purchased a life annuity for $30,000. He begins receiving $300 per month in January. What amount is included in his gross income?

      Expected return =

      Exclusion % =       Cost    

                              Exp. Return

      Excluded Income =

      Gross income =

2.    Don has been employed by Longbow Corporation for 25 years. During that time, he bought an annuity at a cost of $50 per month ($15,000 total cost). The annuity will pay him $200 per month after he reaches age 69. Don turned 69 in April 2020 and received 8 payments on the contract.

a. How much gross income does Don report in the current year?

       Expected return = 16.8* x ($200 x 12) = $40,320         *Don is age 69 when the annuity payments begin.

       Exclusion % =    Cost    =              $15,000 = 37.2%

                                Exp. Ret./Value      $40,320

       Monthly Excluded Income = 37.2% x $200 = $74

     Monthly Gross Income = $200 - $74 = $126       

      Annual Gross Income = $126 x 8 monthly receipts = $1,008 (May thru December)

b.    What amount would be included in Don’s gross income in 2038?

      [$15,000 ÷ $74 (exclusion amount)] = 202.7 payments   So, cost is recovered with 203rd payment:

      2020:

      2021 – 2036:

       2037:

        Don recovers his investment of $15,000 (with his 203^rd monthly receipt) in March 2037. Therefore, in 2038, he will include

c.    Assume Don dies on August 4, 2031, after receiving his August payment. What amount would be included and deducted on his final tax return?

            2020:

            2021 – 2030:

            2031:

       Don only received 136 of the 202 payments expected from the contract. Therefore, he has not recovered all of his $15,000 investment through his excluded portions.

      Income on 2031 return:

      Deduction on 2031 return:

Overview of Business Entity Taxation:

Answer 1

CLAIM OF RIGHT

ans 1:- Clara recieved $450 i.e. 1st month rent in advance and that has to be reported into income as income has to be reported on reciept or accrual basis whichever earlier. The $500 recieved as Deposit which is repayable if the garage isn't damaged stays as deposit & advances under balance sheet and hence need not be reported as an Income.

Ans 2:- the reciept of Advance by Shenoy is not an income as it has to be repaid if she does not produce any acceptable plan, the reciept stays as advances under Liability and not as an income; it becomes income to be reported only if any plan produced by her is accepted by the university. hence, if the contract gets approved by the university in December month itself, the advnce recived shall become an Income.

Ans 3:-

a. Income is to be reported on accrual or reciept whichever earlier, the income of $20000 has been recieved in May month itself, hence the full income of $20000 is to be reported in current year 2020.

b.deductions can be claimed on actual payment of expenses or accrual of expenses whichever earlier, the accrual to pay $3000 arises on the order of the court which has came in 2021 and hence the deduction of $3000 has to be claimed in 2021 itself and not in 2020.

FIXED ANNUITY EXAMPLE

Ans 1:- Expected return/Value of Annuity:- $100(amount to be received oer month)*12(months)*10(Years) = $12000.

Ans 2:- Exclusion % = $4000(cost)/$12000(expected return/value)*100 = 33.33%

Ans 3:- Excluded Income = Income earned*Exclusion %

Excluded Income = $1200*33.33%

Excluded Income = $399.96 rounded off to $400

Ans 4:- Gross Income = Total Income - Excluded Income

Gross Income = $1200-$400

Gross Income = $800.

LIFE ANNUITY EXAMPLES

Ans 1:- Expected Returns = amount recieved per month * 12(months in a year)*life expectancy(life expectancy of a country-current age)

Expected Returns = $300*12*10(78-68) (considering life expectancy of U.S.A at 78years

Expected returns = $36000

Exclusion % = Cost/Expected returns

Exclusion % = $30000/$36000*100 = 83.33%

Excluded income = Expected returns* Exclusion%

Monthly Excluded income = $300*83.33% = $249.99= $250 (rounded off)

Monthly Gross income = monthly income - monthly Excluded Income

Monthly Gross Income = $300-$250= $50

Annual Gross Income = monthly gross Income * 12

Annual Gross Income = $50*12 = $600.

Ans 2:-

a.Expected return = 16.8* x ($200 x 12) = $40,320

*Don is age 69 when the annuity payments begin.

Exclusion % =    Cost/Epected Returns

Exclusion %= $15,000/$40320 = 37.2%

Monthly Excluded Income = exclusion% x monthly Income

Monthly Excluded Income = 37.2% x $200 = $74

Monthly Gross Income = monthly Income - Excluded Income

Monthly Gross Income = $200 - $74 = $126

Annual Gross Income = $126 x 8 monthly receipts = $1,008 (May to December)

b.2020: as determined above, the Gross Income for 2020 is $1008.

      2021 – 2036: gross Income x No. of Years = $1008*16 = $16128.

       2037: $126*3 (203rd payment)+ $200*9(from 204th payment onwards) = $378+$1800= $2178.

Gross income for year 2038 will be $200*12 = $3600.

c.if don dies in august 2031, the investment he made of $15000 isnt recovered yet hence the monthly gross income x 8(periodic reciepts) shall be shown in Tax Return i.e. $126*8 = $1008.