EXCLUSIONS Paul is a graduate student in the last semester of an accounting program at State University. This past summer he was an inter with a CPA firm, working in the compliance area. Paul was paid well enough for his work as an intern that he was able to pay for his meals and lodging and to save some for school. The CPA firm was so pleased with Paul’s work that at the conclusion of his internship, he was given a bonus of {$1,500 more than the firm had agreed to pay him. The extra amount was intended to help with his gradu- ate schoo! expenses. The CPA firm has offered him a fulltime job after he completes his graduate program in December. Because of his excellent academic record, the university has awarded Paul a graduate assistantship that “waives his tution of $6,000 per semester and pays him $400 per month. Paul is required to teach a principles ‘of accounting course each semester. Paul has used the $400 per month for books and for roomand board. In November, Paul was crossing a street in the pedestrian crosswalk when a delivery van struck him. The driver of the truck had a blood alcohol level of .12. Paul suffered a severe injury to his right arm that has ‘delayed his starting date for work by three months. The delivery company’s insurance company settled the ‘case by paying damages, itemized as follows: Compensatory damages: ‘Medical experses '$ 30,000 Injury to Pausright arm 100,000 Pain and suffering ‘50,000 Lossof income 15,000 Legal fees 225,000 Punitive damages 160,000 a Paul's mother was with him in the crosswalk, Fortunately, the van did not hit her, and she was not physi cally injured. But she did suffer emotional distress and received $25,000 in the settlement. Besides being Paul's gislfriend, you also are a senior accounting major and have a keen interest in txa- sion. You tell Paul that you will look into the tax consequences ofthe settlement.S10, 200 {4009 8 Tax-exempt interest. Do not include on line a... Gross income.. 10 Taxable refunds, credits, or offsets of state and local income taxes... 19 Unemployment compensation . 21 Other income. List type and amount Less: Deductions for adjusted grass income Adusted gross income... Less: The greater of total temized deductions or the standard deduction. Personal and dependency exemptions. ‘Taxable income ‘Taxon taxable income (see Tax Tables or Tax Rate Schedules). Less: Tax credits (including income taxes withheld and prepaid... Tax due (or refund). lle dle g Ele ‘Tax advisers spend countless hours trying to develop techniques to achieve taxexempt status for income. Employee benefits planning is greatly influenced by the availability of certain types of exclusions. Taxes play an important role in employee benefits, as well as in other situations, because attaining an exclusion is another means of enhancing after-tax income. For example, for a person whose combined Federal and state marginal tax rate is 40 percent, $1.00 of tax- exempt income is equivalent to $1.67 [$1 + (1 — 4)] in income subject to taxa tion. The tax adviser's optimal strategy is to attach the right labels or provide the right wording to render income nontaxable without affecting the economics of the transaction. Consider the case of an employee who is in the 28 percent marginal tax bracket and is paying $3,000 a year for health insurance. If the employer pro- vided this protection in a manner that qualified for exclusion treatment but reduced the employee's salary by $3,000, the employee's after-tax and afterinsur- ance income would increase at no additional cost to the employer. Salary received to use to purchase health insurance $3,000 Less: Taxes ($3,000 x 28%) (840) Cash available to purchase health insurance $2,160 Less: Cost of health insurance 3,000) Excess of cost of health insurance over cash available _840)