Question

Has the taxpayer in each of the following situations received taxable income? If so, when should the income be recognized? Explain.
a. Charlotte is a lawyr who specializes in drafting wills. She wants to give her husband a new gazeb for Christmas. In November, she makes a deal with Joe a local handyman, to build a gazebo. In return, Charlotte is to draft a will for Joe's father. The gazebo normally would cost $3000, which is approximately what Charlotte would charge for drafting the will. Joe builds the gazebo in time for Christmas. Charlotte drafts the will and delivers it to Joe the following January.

b. Ed buys 500 shares of Northstar stock in January 2015 for $4000. On December 3,2015, the shares are worth $4600. In March 2016, Ed sells the shares for $4500.

c. Dayo is the director of marketing for Obo Inc. In December, the board of directors of OBO votes to give Dayo $10000 bonus for her excellent work throughout the year. The check is ordered and written on December15 but is misplaced in the mail room and is not delivered to Dayo until January 5.

d. John is unemployed. During the current year, he receives $4000 in unemployment benefits. Because the unemployment is not enough to live on, John sells drugs to support himslef. His total revenue for the year is $120000.The cost of the drugs is $60000..

Answer 1

Answer:

a. Both Charlotte and Joe have received taxable income with a difference in timing. Charlotte will recognize the income in December while Joe will recognize it in January

b. Ed has received taxable income with a difference in timing. It will be recognized in 2016

c. Dayo has received taxable income with a difference in timing. It will be recognized during the year

d. John has received taxable income for the year.

Explanation:

Lets look at each option and understand how taxable income is determined and how the timing will be determined as well.

a. Through the deal that Charlotte made with Joe, each will receive some form of remuneration that will be considered as income. For Joe, the income is in the form of a will which would generally cost him $3000. For Charlotte, it the income is in the form of a gazebo with the same value of $3000. The income will be recognized on the basis of when it is received by each taxpayer. So far Charlotte, the gazebo was received in December, therefore, the income will be recorded in this year only. Joe on the other hand, received his income in January, therefore, he will record the income next year.

b. In December 2015, the value of the stock increases by $600. However, this capital gain is not recognized as income since unrecognized income such as this is not classified as taxable income for the year. Since Ed continues to possess ownership of the stock in December, no income will be recognized in December. Now, Ed sells the stock in March of 2016 and recorded a gain of $500. The capital that he recovered will not be taxed under the law. The gain that he realized on sale of $500 will count towards taxable income for the year 2016.

c. Dayo will not include the bonus as taxable income for the year. For income to be recorded as taxable income, the associated value needs to be received by the taxpayer. As far as Dayo is concerned, she had not received the value of the bonus in December. The check was lost by the mail room which was an act completely beyond Dayo's control. Had Dayo misplaced the check herself she would have had to recognize the income in December. In this case, however, the taxable income will be recognized in January next year.

d. Two things will happen here. First, John will have to record income received from his drug operations as taxable. Even though the nature of the business is illegal, it is included under the umbrella of income. The taxable income from the drug operations would be to the tune of $60,000 which is the profit. Now as far as unemployment benefits are concerned, they are considered as a substitute for income that a taxpayer may earn from other sources. They are tax deductible up to a certain amount but some of it will be considered taxable. Therefore, both incomes will be recorded as taxable income in the current year.