IRS Income and Assets 3 — Questions and Answers
Question 1: A taxpayer receives a life insurance death benefit of $200,000 as the named beneficiary. How is the death benefit treated?
- Fully taxable as ordinary income
- Excluded from gross income (Correct answer)
- Taxable only on amounts above $50,000
- Treated as a capital gain
Correct answer: Excluded from gross income
Life insurance death benefits paid to a beneficiary are generally excluded from gross income under IRC §101(a).
Question 2: Which method of accounting requires income to be reported when earned and expenses deducted when incurred, regardless of cash flow?
- Cash method
- Accrual method (Correct answer)
- Hybrid method
- Installment method
Correct answer: Accrual method
The accrual method recognizes income when earned and expenses when incurred, not when cash is actually received or paid.
Question 3: A taxpayer sells a principal residence with a realized gain of $400,000. They are married filing jointly and meet all ownership and use tests. How much gain is excluded?
- $0 — gain on home sales is always taxable
- $250,000
- $400,000 — the entire gain is excluded
- $500,000 limit applies, so the entire $400,000 is excluded (Correct answer)
Correct answer: $500,000 limit applies, so the entire $400,000 is excluded
Married filing jointly taxpayers may exclude up to $500,000 of gain on the sale of a qualifying principal residence; the $400,000 gain falls entirely within this limit.
Question 4: What is the basis of property received as a gift if the fair market value at the time of the gift is LESS than the donor's adjusted basis?
- Always the donor's adjusted basis
- Always the fair market value at the date of gift
- The donor's basis for gain purposes; FMV for loss purposes (Correct answer)
- Zero basis
Correct answer: The donor's basis for gain purposes; FMV for loss purposes
When FMV is less than the donor's basis, the donee uses FMV to determine a loss and the donor's basis to determine a gain (the 'dual basis' rule).
Question 5: A taxpayer receives alimony payments under a divorce agreement executed in 2020. How does the recipient treat these payments?
- Taxable income under the pre-2019 rules
- Excluded from income because the agreement was post-2018 (Correct answer)
- Taxable only if payments exceed $15,000 per year
- Reported as a capital gain
Correct answer: Excluded from income because the agreement was post-2018
Under the Tax Cuts and Jobs Act, alimony received under agreements executed after December 31, 2018 is excluded from the recipient's gross income.
Question 6: Which of the following is NOT included in a taxpayer's gross income?
- Tips received by a waiter
- Forgiveness of a $10,000 credit card debt by a bank
- Workers' compensation benefits received due to a job injury (Correct answer)
- Rental income from a vacation property rented 100 days
Correct answer: Workers' compensation benefits received due to a job injury
Workers' compensation benefits are specifically excluded from gross income under IRC §104(a)(1).
Question 7: A taxpayer holds depreciable rental property for 3 years and then sells it at a gain. Which code section may cause part of the gain to be taxed as ordinary income?
- Section 1221
- Section 1231
- Section 1250 (Correct answer)
- Section 1014
Correct answer: Section 1250
Section 1250 recaptures depreciation taken on real property as ordinary income (unrecaptured Section 1250 gain is taxed at a maximum 25% rate).
IRS Income and Assets 3
A taxpayer receives a life insurance death benefit of $200,000 as the named beneficiary.
How is the death benefit treated?