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Case study:Disability income

Sherwood received disability income of $6,000. All premiums on the health and accident policy were paid by his employer and included in Sherwood”s income. In addition, he received compensatory damages of $10,000 as a result of inadvertent poisoning at a restaurant. He received no other income during the year. How much income does Sherwood report on his tax return?

a. Incorrect. The health and accident payments of $6,000 and the compensatory damages for physical injury are not included in income. The health and accident payments are considered as paid by the taxpayer because they were included in income and thus are not taxable. The compensatory damages were paid in regard to a physical injury and thus are not taxable.

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b. Incorrect. The compensatory damages of $10,000 are not taxable because they are paid in regard to a physical injury.

c. Incorrect. The health and accident payments of $6,000 are not taxable because the employee is considered to have paid the health insurance premiums. While paid with employer contributions, these amounts were included in income and thus are considered paid by the employee.

d. Correct. Sherwood has $0 reportable income for the year. His disability income of $6,000 is not taxable because he paid tax on the premiums paid by his employer. The $10,000 of compensatory damages is not taxable because it was received because of a physical injury.

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