Question

Chapter 3

1. Explain how income is recognized under the cash method of accounting.

2. Are there circumstances in which income is recognized even when a cash basis taxpayer does not receive cash? Explain.

3. What is meant by the concept of constructive receipt?

10. Under what circumstances is a dividend nontaxable to a shareholder recipient?

12. Under what circumstances is a state or local income tax refund included in the taxable income of a taxpayer?

15. Congress has chosen to exempt certain income from taxation, such as scholarships, gifts, life insurance proceeds, municipal bond interest, and employee fringe benefits. Given that one of the primary purposes of the IRC is to raise revenue for the government, why do you think Congress would provide these and other exemptions?

Please also provide references

Also please provide new answers

Answer 1

1. Explain how income is recognized under the cash method of accounting?

Answer: Income is recognized under the cash method of accounting when the taxpayer receives or constructively receives cash, property, or services. For Example when sale is made no entry will be passed but when the amount for the sale is received entry will be passed for that.

2. Are there circumstances in which income is recognized even when a cash basis taxpayer does not receive cash? Explain?

Answer: Yes. A taxpayer can indirectly receive cash. If a cash-basis taxpayer owes money to a bank and someone else pays the loan to the bank on behalf of the taxpayer, the taxpayer must record income for the amount of debt repaid by the third party. Another example is interest on certain U.S. Savings Bonds. A taxpayer can elect to report the interest on the bonds annually even though no cash is received. Another example is he can tell the debtor to directly pay to the creditor where he indirectly receives cash and passes entry.

3. What is meant by the concept of constructive receipt?

Answer: Constructive receipt of income means that the income is available to or in the control of the taxpayer regardless of whether the taxpayer chooses to utilize the income. For example, interest income credited to a savings account at year-end is constructively received even if the taxpayer does not withdraw it for use.

10. Under what circumstances is a dividend nontaxable to a shareholder recipient?

Answer: When a distribution is made by a corporation to its shareholders, the distribution is a taxable dividend to the extent of current or accumulated earnings and profits of the corporation. If the distribution exceeds E&P, it is nontaxable return of capital to the extent of the shareholder's basis in the stock. Once the distribution exceeds basis, the excess is treated as a capital gain. Thus, a distribution is nontaxable if it is in excess of the E&P of the corporation and the excess is less than the shareholder's basis in the stock.

12. Under what circumstances is a state or local income tax refund included in the taxable income of a taxpayer?

Answer: If a taxpayer deducted state or local taxes as an itemized deduction in the prior year, the taxpayer must report income in the year in which the refund was received. The taxable amount is the lesser of (a) the amount received, or (b) the amount deducted in the prior year, or (c) the amount by which the itemized deductions exceed the standard deduction. If the taxpayer did not itemize deductions in the prior year (i.e., took the standard deduction), no amount of the refund is taxable.

15. Congress has chosen to exempt certain income from taxation, such as scholarships, gifts, life insurance proceeds, municipal bond interest, and employee fringe benefits. Given that one of the primary purposes of the IRC is to raise revenue for the government, why do you think Congress would provide these and other exemptions?

Answer: One significant reason is to promote or not discourage certain actions by taxpayers. Scholarships often enable individuals to attend school. Taxing the scholarship would, at least, discourage individuals from seeking more education. Another reason for an exemption is to not burden taxpayers with undue recordkeeping requirements. An example would be certain employee fringe benefits such as a de minimis gift.

A de minimis fringe benefit is an item of economic value given to employees, the value of which is so small that keeping track of which employees received the benefit is administratively impractical. Examples include: small holiday gifts such as turkeys or hams; holiday parties; birthday gifts; free coffee, etc.