Chapter 15—In Class Problems
1. Wallace Corporation needs an additional worker on a multiyear project. It could hire an
employee for a $30,000 annual salary. Alternatively, it could engage an independent contractor
for a $35,000 annual fee. If Wallace's marginal income tax rate is 35%, calculate the after-tax
cost of each alternative.
Wallace would owe payroll tax for the employee of $2,295 ($30,000 * 7.65%). Employee after-
tax cost is $20,992 [($30,000 + $2,295) * (1 - 35%)]. Independent contractor after-tax cost is
$22,750 [$35,000 * (1 - 35%)].
2. An employee receives $110,000 of group term life insurance coverage per year. The coverage
cost his employer $90. The IRS's uniform applicable rate is $0.43 per year per $1,000 of
coverage. What amount is taxable to the employee?
Use IRS rates: $110,000 - $50,000 excluded = $60,000 excess/$1,000 * $0.43 = $25.80
3. Nelson is employed by Washington Corporation, which provides its employees with free
childcare one day a week. If the childcare were not available, Nelson would have to pay $50 a
month. Washington also provides a complete family medical plan to its employees, in which
Nelson, his spouse and their two children participate. Nelson's annual cost of comparable
insurance would be $8,000. Ignoring payroll tax implications and assuming Nelson's marginal
tax rate is 35%, how much additional salary would he have to earn to provide himself with
childcare and medical insurance?
Nelson would need after-tax salary of $8,600 ($8,000 + $50 * 12); before tax salary would be
$13,231 [$8,600/(1 - 35%)].
4. Six years ago, HOPCO granted Lin Sing a nonqualified option to purchase 1,000 shares of the
corporation's stock at a strike price of $55 per share. On the date the option was granted, the
market price of the stock was $50 per share and had a readily ascertainable value of 2 dollars.
This year, Lin Sing exercised the option on a date when the market price of the stock was $64
per share. How much taxable income must she recognize in the year the option is granted? What
is Lin’s basis in the stock? If Lin sells the stock for $79 per share two years after she acquired it,
what is her recognized gain?
2000 ordinary income at grant, Basis of 57,000, Gain of 22,000
5. Two weeks after graduation, Andrew moved from Boston to Providence to begin work. He
paid a moving company $2,500 to move his things. He drove his car, paid $175 for gas and oil,
$50 for a room and $60 on food. One month prior to graduation Andrew flew to Providence to
locate an apartment. This trip cost him $800 (including $60 for meals). He was not reimbursed
for any of the move-related expenses. What is his allowable deduction for these moving
expenses?
Your life is now easier. There is no longer a moving deduction or the ability to exclude from
income employer reimbursement for moving. Well, except for military personnel. But I would not
test calculations, just the concept.
6. Louise terminated her employment and received a cash distribution from her qualified
retirement plan in the amount of $120,000. She made a qualified rollover contribution of
$100,000. If her marginal tax rate is 30% and she is 45 years old, what is the total amount of
taxes she must pay on the distribution?
$2,000 (10% penalty on $20,000 not rolled over) plus tax on $20,000 at 30%. = $8,000
7. Mike is working his way through college and trying to make ends meet. Tara, a friend, is
graduating soon and tells Mike about a really great job opportunity. She is the onsite manager
for an apartment complex catering to students. The job entails working in the office for about 10
hours a week, collecting rent each month, and answering after-hours emergency calls. The pay is
$10 per hour, plus a rent-free apartment (worth about $500 per month). Tara then tells him the
best part: the rent-free apartment is tax-free as well. Knowing that you are a tax student, Mike
asks you if the rent-free apartment is really tax free or if this is just another scam. Explain to
Mike whether the compensation for the apartment is really a nontaxable fringe benefit.
The value of an apartment or lodging to an employee may be excluded from taxable income if
the benefit is provided for the convenience of the employer and is required as a condition of
employment. Since Mike is required to live on the premises in order to be an “onsite”
manager, and he does so to provide services to the other tenants he may exclude the value of
the apartment from his income as a nontaxable fringe benefit under §132.
8. Over the past three years, Sherry has contributed a total of $12,000 to a Roth IRA account
($4,000 a year). The current value of the Roth IRA is $16,300. In the current year, Sherry
withdraws $14,000 of the account balance to purchase a car. Assuming Sherry is in a 25 percent
marginal tax bracket, how much of the $14,000 withdrawal will she retain after taxes to fund her
car purchase?
Because Sherry has made a withdrawal from her Roth IRA within five years of opening it, she
has received a nonqualified distribution. Nonqualified distributions are non-taxable to the extent
they are attributable to contributions; the earnings made on such contributions are taxed as
ordinary income and subject to a 10% penalty. In this instance, Sherry has withdrawn $2,000 of
earnings (14,000 withdrawal – 12,000 contributions) and will pay taxes of $500 (25% × 2,000)
and a penalty of $200 (10% × 2,000). Of the $14,000 withdrawn, Sherry will retain after-taxes
$13,300 ($14,000 withdrawal – 500 taxes – 200 penalty).