Taxation of Individuals: Deductions, Tips, and Compensation

This document provides solutions to a homework assignment on individual taxation. The first question addresses the deductibility of charitable contributions, specifically focusing on a donation to the EI Salvador Relief fund and referencing relevant sections of the US tax code. The second question examines the reporting of tips by employees and employers in large food or beverage establishments, detailing the requirements and regulations. The third question compares and contrasts sick pay and workers' compensation, guiding the selection of the correct compensation for tax purposes, and explaining the tax implications of each. The final question explores qualified employee discounts and their impact on gross income, referencing the relevant US tax code sections. The solutions are supported by references to the US tax code and other relevant sources.

Question 1
1. A deduction is allowable to an individual under section 170 only for charitable
contributions actually paid during the taxable year, regardless of when pledged and
regardless of the method of accounting employed by the taxpayer in keeping his books
and records. A contribution to an organization described in section 170(c) is deductible
even though some portion of the funds of the organization may be used in foreign
countries for charitable or educational purposes. The deduction by an individual
for charitable contributions under section 170 is limited generally to 20 percent of
the taxpayer's adjusted gross income (computed without regard to any net operating
loss carryback to the taxable year under section 172).
2. This is governed by section 170(c) (2) (A). Under this section Charitable contribution is
defined as a contribution, or gift to or for the use of—
3. (1) A State, a possession of the United States, or any political subdivision of any of the
foregoing, or the United States or the District of Columbia, but only if the contribution or
gift is made for exclusively public purposes.
4. (2) A corporation, trust, or community chest, fund, or foundation—
(A) created or organized in the United States or in any possession thereof, or under the
law of the United States, any State, the District of Columbia, or any possession of the
United States;
(B) organized and operated exclusively for religious, charitable, scientific, literary, or
educational purposes, or to foster national or international amateur sports competition
(but only if no part of its activities involve the provision of athletic facilities or
equipment), or for the prevention of cruelty to children or animals
(C) no part of the net earnings of which inures to the benefit of any private shareholder or
individual; and

(D) which is not disqualified for tax exemption under section 501(c)(3) by reason of
attempting to influence legislation, and which does not participate in, or intervene in any
political campaign on behalf of (or in opposition to) any candidate for public office.
5. In the present case Susan has contributed $10000 to EI Salvador Relief fund, which is
organized in San Salvador. This fund is used to provide basic necessities to the victims of
the Mexican fires like food, shelter, clothes etc.
6. EI Salvador/ San Salvador is a small Central American Nation. The trust is registered in
this nation only. So it is covering under the definition of the charitable contribution under
section 170 (c)(2)(A).
7. Since it is meeting the condition of the section that the fund is registered in US, it does
not matter where the fund is utilizing its money. Whether it is spending money for the
welfare of US or for the welfare of any other country.
8. In the present case, this particular fund is spending money for Mexican fires. Despite of
this fact, Susan is eligible for the deduction as per section 170.
9. References: non, (2017). [online] Available at: http://26 CFR 1.170-2 - Charitable
deductions by individuals; limitations (before amendment by Tax Reform Act of 1969).
[Accessed 24 Oct. 2017].

Question 2
1. Every employee who, in the course of his employment by an employer, receives in
any calendar month tips which are wages (as defined in section 3121(a) or section
3401(a)) or which are compensation (as defined in section 3231(e)) shall report all
such tips in one or more written statements furnished to his employer on or before the
10th day following such month.
2. If the tax imposed by section 3101 or section 3201 (as the case may be) with respect
to tips reported by an employee pursuant to subsection (a) exceeds the tax which can
be collected by the employer pursuant to section 3102 or section 3202 (as the case
may be), the employer shall furnish to the employee a written statement showing the
amount of such excess.
3. In the case of a large food or beverage establishment, each employer shall report to
the Secretary, at such time and manner as the Secretary may prescribe by regulation,
the information regarding the tips along with other information with respect to each
calendar year.
4. (D)The sum of—
(i) the aggregate amount reported by employees to the employer under subsection (a),
plus
(ii)the amount the employer is required to report under section 6051 with respect to
service charges of less than 10 percent.
5. For purposes of paragraphs (1)(E) and (2)(C), the employer of a large food or
beverage establishment shall allocate (as tips for purposes of the requirements of this
subsection) among employees performing services during any payroll period who
customarily receive tip income an amount equal to the excess of:—
6. (i)8 percent of the gross receipts (for allocable receipts) of such establishment for the
payroll period, over

7. (ii)the aggregate amount reported by such employees to the employer under
subsection (a) for such period
8. For purposes of this subsection, the term “large food or beverage establishment”
means any trade or business (or portion thereof)—(A)which provides food or
beverages, (B)with respect to which the tipping of employees serving food or
beverages by customers is customary, and (C)which normally employed more than 10
employees on a typical business day during the preceding calendar year.
9. Rulings- Rev. Proc. 2005–41, page 90
10. The Fresh cut employs more than 30 waiter/ waitresses. Thus it meets the criteria of falling in
the definition of large food or beverage establishment.
11. Form W-2 is filed by an employer for each of his employees (who provides services to his
employer) who pays remuneration including non-cash payments of $600 or more.
12. As per section, employer will show the excess of the tips actually received which is reported
by employee to employer or 8% of the allocable receipts. Thus, if $2400 is excess of both of
the above conditions then employer has shown the right amount.
13. References: Anon, (2017). [online] Available at: http://26 U.S. Code § 6053 - Reporting of
tips [Accessed 24 Oct. 2017].

Question 3
1. Harry should select weekly workers compensation payment as the compensation amount
is not included in th income for calculation of Income Tax below are the further
explanation for selecting worker compensation fund over sick pay distribution.
2. Sick Pay
Sick pay benefits received from an employer or from a plan paid for by an employer are
taxable as wages. However in certain instances, employee benefits may be taxable as
wages depending on employees' payments.
3. Premiums for employees' sick pay insurance paid by the employer than the benefits
received are taxable and are included as wages;
4. The benefits received are not taxable if employees pay all of the costs of their own
coverage;
5. All or part of the cost of their sick pay insurance coverage with "pre-tax" dollars is paid
by the employees, the benefits received are taxable and are included as wages;
6. Cost of the sick pay insurance for the employees is shared by the employer and
employee, the only portion of the benefits that matches the percent of the employer's
contribution is taxable and included as wages income and the remaining amount is not
taxable income.
7. Nonresidents receiving sick pay paid by their employers should report them as wages.
The same rules apply for nonresidents as residents.
8. W-2:
The amount of taxable income will appear in the wage boxes of the W-2, federal wages
in box 1 and state wages in box 16. The amount of the benefit that is not taxable will
appear in box 13 and will be labeled with a "J".

9. Withholding Requirements: Sick pay received from an employer is subject to income tax
withholding as if it were wages. If it is from a third party such as an insurance company,
it is not subject to withholding unless requested by the taxpayer.
10. Workers' Compensation Under the Workmen's Compensation Acts, gross income
does not include amounts received as compensation for personal injuries or sickness
while employees are out of work. However, if an employee returns to work, is assigned to
"light duties", and continues to receive workers compensation, such amounts are taxable.
11. Regular Salary Paid While Receiving Workers Compensation:
If an employer continues to pay a regular salary to an employee who is out of work and
who is receiving workers compensation, the employee must turn over the workers
compensation payments to the employer. The amount to be included in gross income is
the difference between what was paid and what was returned.
Note: Not all payments for job related illness or injury qualify as tax free workers
compensation. Unless the statute or regulation authorizing the disability payment restricts
awards to "on the job" illness or injury, the payment will be taxable.
12. Where to Report on Original Tax Return; What to Enclose:
If Claiming the Incapacitated Firefighter or Police Officer Income Exclusion - Schedule
Y Deduction
13. For residents, the amount of income must be reported on Mass Form 1, Line 3 as wages
and is then excluded on Schedule Y, Line 4. Fill in the appropriate oval.
14. For nonresidents and part-year residents, the amount of income subject to Mass tax must
be reported on Mass Form 1-NR/PY, Line 5 as wages and is then excluded on Schedule
Y, Line 4. Fill in the appropriate oval.
15. References: Anon, (2017). [online] Available at: http://Workers' Compensation
[Accessed 24 Oct. 2017].

Question 4
1. As per US code 132 Gross total income shall not include any fringe benefit which
qualifies as a—
a. qualified employee discount
2. In the given question Ben receive $ 2500 plus $ 1500 as employee discount which is 60%
of the price which are normally traded to outside customer.
3. In US Code 132 :
Qualified employee discount definedFor purposes of this section—
“qualified employee discount” means any employee discount with respect to qualified
property or services to the extent such discount does not exceed—
 in the case of services, 20 percent of the price at which the services are being
offered by the employer to customers.
4. So as per the above section only 20% amount is excluded from the Gross total income
and remaining amount is include to calculate Gross Income of Ben i.e. $ 2,667.
5. Below are the points we need to remember while calculating Gross income of employee
we need to consider.
6. Gross Income: Except as otherwise provided in this subtitle, gross income means all
income from whatever source derived, including (but not limited to) the following items
in case of employer & employee relationship:
a. Compensation for services, including fees, commissions, fringe benefits, and
similar items;
7. As per Section 119 of US Act, Meals and lodging furnished to employee, his spouse, and
his dependents, pursuant to employment: There shall be excluded from gross income of
an employee the value of any meals or lodging furnished to him, his spouse, or any of his
dependents by or on behalf of his employer for the convenience of the employer, but only
if—

8. in the case of meals, the meals are furnished on the business premises of the employer, or
9. in the case of lodging, the employee is required to accept such lodging on the business
premises of his employer as a condition of his employment.
Special rules For purposes of subsection (a)—
10. Provisions of employment contract or State statute not to be determinative
In determining whether meals or lodging are furnished for the convenience of the
employer, the provisions of an employment contract or of a State statute fixing terms of
employment shall not be determinative of whether the meals or lodging are intended as
compensation.
11. Certain factors not taken into account with respect to meals
In determining whether meals are furnished for the convenience of the employer, the fact
that a charge is made for such meals, and the fact that the employee may accept or
decline such meals, shall not be taken into account.
12. Certain fixed charges for meals
a. In generalIf—
i. an employee is required to pay on a periodic basis a fixed charge for his
meals, and
ii. such meals are furnished by the employer for the convenience of the
employer, there shall be excluded from the employee’s gross income an
amount equal to such fixed charge.
b. Application of subparagraph (A)Subparagraph (A) shall apply—
i. whether the employee pays the fixed charge out of his stated
compensation or out of his own funds, and
ii. only if the employee is required to make the payment whether he accepts
or declines the meals.
13. Meals furnished to employees on business premises where meals of most employees are
otherwise excludable

14. All meals furnished on the business premises of an employer to such employer’s
employees shall be treated as furnished for the convenience of the employer if, without
regard to this paragraph, more than half of the employees to whom such meals are
furnished on such premises are furnished such meals for the convenience of the
employer.
15. References: Anon, (2017). [online] Available at: http://U.S. Code § 119 - Meals or
lodging furnished for the convenience of the employer [Accessed 24 Oct. 2017]

Question 5
1. § 1.274-2 (C)Directly related entertainment -
(1)In general. Except as otherwise provided in paragraph (d) of this section
(relating to associated entertainment) or under paragraph (f) of this section (relating
to business meals and other specific exceptions), no deduction shall be allowed for
any expenditure for entertainment unless the taxpayer establishes that the
expenditure was directly related to the active conduct of his trade or business within
the meaning of this paragraph.
2. (2)Directly related entertainment defined. Any expenditure for entertainment, if it
is otherwise allowable as a deduction under chapter 1 of the Code, shall be considered
directly related to the active conduct of the taxpayer's trade or business
1. (3)Directly related in general. Except as provided in subparagraph (7) of this
paragraph, an expenditure for entertainment shall be considered directly related to the
active conduct of the taxpayer' strade or business if it is established that it meets all of
the requirements of subdivisions (i), (ii), (iii) and(iv) of this subparagraph.
2. (4)Expenditures in clear business setting. An expenditure for entertainment shall be
considered directly related to the active conduct of the taxpayer's trade or business if
it is established that the expenditure was for entertainment occurring in a clear
business setting directly in furtherance of the taxpayer's trade or business.
3. Generally, entertainment shall not be considered to have occurred in a clear business
setting unless the taxpayer clearly establishes that any recipient of the entertainment
would have reasonably known that the taxpayer had no significant motive, in
incurring the expenditure, other than directly furthering his trade or business.
4. Objective rather than subjective standards will be determinative. Thus, entertainment
which occurred under any circumstances described in subparagraph (7)(ii) of this

paragraph ordinarily will not be considered as occurring in a clear business setting.
Such entertainment will generally be considered to be socially rather than
commercially motivated.
5. Expenditures made for the furtherance of a taxpayer's trade or business in providing a
“hospitality room” at a convention (described in paragraph (d)(3)(i)(b) of this section)
at which goodwill is created through display or discussion of the taxpayer's products,
will, however, be treated as directly related.
6. In addition, entertainment of a clear business nature which occurred under
circumstances where there was no meaningful personal or social relationship between
the taxpayer and the recipients of the entertainment may be considered to have
occurred in a clear business setting.
7. For example, entertainment of business representatives and civic leaders at the
opening of a new hotel or theatrical production, where the clear purpose of
the taxpayer is to obtain business publicity rather than to create or maintain the
goodwill of the recipients of the entertainment, would generally be considered to be
in a clear business setting.
8. Also, entertainment which has the principal effect of a price rebate in connection with
the sale of the taxpayer's products generally will be considered to have occurred in a
clear business setting.
9. Such would be the case, for example, if a taxpayer owning a hotel were to provide
occasional free dinners at the hotel for a customer who patronized the hotel.
10. (5)Expenditures for services performed. An expenditure shall be considered
directly related to the active conduct of the taxpayer's trade or business if it is
established that the expenditure was made directly or indirectly by the taxpayer for
the benefit of an individual (other than an employee), and if such expenditure was in
the nature of compensation for services rendered or was paid as a prize or award

which is required to be included in gross income under section 74 and the regulations
thereunder.
11. For example, if a manufacturer of products provides a vacation trip for retailers of his
products who exceed sales quotas as a prize or award which is includible in gross
income, the expenditure will be considered directly related to the active conduct of
the taxpayer's trade or business.
12. 7)Expenditures generally considered not directly related. Expenditures for
entertainment, even if connected with the taxpayer's trade or business,
will generally be considered not directly related to the active conduct of
the taxpayer's trade or business, if the entertainment occurred under circumstances
where there was little or no possibility of engaging in the active conduct of trade or
business.
13. The following circumstances will generally be considered circumstances where there
was little or no possibility of engaging in the active conduct of a trade or business
14. In case Mulne Tc Memo 1996-320, Employer has claimed deduction of parking
expenses. As per section 162, any expenditure which is necessary for the running of
trade or business can be claimed as an expenditure. But parking provided to employee
is not a necessary expense hence not allowable as deduction.
15. In the present case, Wendy, Chair of the School of business used to organize picnics,
party, social hours for the faculty and graduate student. First we have to identify is it
necessary for the running of trade and business. If it boost the morale of faculties and
graduate students, then we can say it is necessary for running of business and it can
be claimed as deduction.
16. Rulings- Rev Rul 63-144, 1963-2 CB 129 and Rev Rul 78-373, 1978-2 CB 108
17. Reference to other cases- Walsh TC Memo 1961-80 and Christensen, 17TC 1456