Income that is excluded or deferred:
Is not included in gross income
1. Excluded income is never taxed
2. Deferred income is taxed when realized in a subsequent year
Definition of gross income for tax purposes:
1. �61(a) - "Gross income means all income from whatever source derived"
2. Reg. �1.61-(a) states "Gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, pro
Taxpayers recognize gross income when:
1. They receive an economic benefit
2. They realize the income, and
3. No tax provision allows them to exclude or defer the income
NOT an Economic Benefit:
Borrowed funds represent a liability, not gross income
Realization Principle:
1. Taxpayer engages in a transaction with another party
2. Transaction results in a measurable change in property rights
Recognition:
Realized income is assumed to be recognized absent a deferral or exclusion provision
Form of Receipt:
1. Realize income whether receive money, property or services
2. Taxpayers have the legal and ethical responsibility to report realized income no matter the form of receipt or whether the IRS knows the taxpayer received the income
Return of capital principle:
1. Gain from the sale or disposition of an asset is included in realized income
2. The cost of an asset is called tax basis
3. Return on capital refers to exclusion of the tax basis from realized income
Return on capital refers to:
Exclusion of the tax basis from realized income; The portion of the proceeds that represents tax basis is excluded from realized income because it does not represent an economic benefit
Recovery of amounts previously deducted:
1. Expenditures are typically deducted in the year paid.
2. Prior deductions may sometimes be reimbursed or refunded in a subsequent year.
3. Tax benefit rule
Tax benefit rule:
Taxpayers receiving a refund of an expenditure deducted in a prior year are only required to include the amount in gross income to the extent that the amount refunded actually tax reduction of taxes in year of the deduction
When to Recognize Income:
1. Individual taxpayers file tax returns for a calendar-year period
2. Corporations often use a fiscal year end
3. Either case, the taxpayer's method of accounting generally determines the calendar year in which realized income is recognized and included
Accounting Methods:
1. Corporation: accrual method of accounting
2. Individuals: Cash method
Constructive Receipt:
1. Taxpayer must realize and recognize income when it is actually or constructively received
2. Deemed to occur when the income is credited to the taxpayers account
Who Recognizes the Income:
1. In addition to determining when taxpayers realize and recognize income, it is important to consider who (which taxpayer) recognizes the income
2. This question arises when Income-shifting strategy is involved:
2a. Assignment of Income
2b. Community Pro
Who Recognizes the Income: Assignment of Income:
1. The assignment of income doctrine holds that the taxpayer who earns income from services must recognize the income
2. Income from property such as dividends and interest is taxable to the person who actually owns the income-producing property
3. To shi
Who Recognizes the Income: Community Property Systems:
1. The state laws of nine states implement community property systems
2. The income earned from services by one spouse is treated as though it was earned equally by both spouses
3. Property acquired by either spouse during the marriage is usually communit
Types of Income:
1. Income from services (Earned Income)
2. Income from property (Unearned Income)
Types of Income: Income from services (Earned Income):
1. Income from labor most common source of gross income
2. Generated by the efforts of tax payer
Types of Income: Income from property (Unearned Income):
1. Include gain or losses from sale of property, dividends, interests, rents, royalties, and annuities
2. Depends on type of income and type of transaction generating income
Types of Income: Annuities:
1. An investment that pays a stream of equal payments over time
2. A portion of each annuity payment as a non-taxable return of capital and the remainder as gross income (Exclusion Ratio)
3. Taxpayers use the annuity exclusion ratio to determine the retur
Types of Income: Annuities: Exclusion Ratio:
1. Exclusion Ratio = Original investment / Expected value of the annuity
2. Ratio = Return of Capital Percentage
Annuities:
1. An annuity may be paid over a person's life
2. Must use IRS table to determine expected value based upon the taxpayer's life expectancy
Types of Income: Property Disposition:
1. Taxpayers can realize a gain or loss when disposing of an asset
2. Taxpayers are allowed to recover their investment in property (tax basis) before they realize any gain
Formula for Calculation Gain (Loss) from Sale of an Asset:
Sale Proceeds - (Selling Expenses) = Amount Realized - (Basis Investment in Property Sold/Principal) = Gain (Loss) on Sale
Types of Income: Other Sources of Income:
Income other than wages or business and property
Types of Income: Income from Flow-through Entities:
1. Individuals may invest in various business entities
2. The legal form of the business affects how the income generated by the business is taxed
3. If the entity is a flow-through entity such as a partnership or S corporation, the income and deductions
Types of Income: Alimony: Tax Law Defines:
1. A transfer of cash made under a written separation agreement or divorce decree,
2. The separation or divorce decree designate the payment as alimony, and
3. The payments cannot continue after the death of the recipient
Types of Income: Alimony: Types of payment that do not qualify as alimony:
1. Property divisions and
2. Child support payments fixed by the divorce or separation agreement
Types of Income: Prizes, awards and gambling winnings are included in gross income unless one of the following applies:
1. Excluded only if (1) made for scientific, literary, or charitable achievement and (2) transferred to a qualified charity.
2. Exclude up to $400 for employee length of service or safety achievement; Awards must be tangible property
Types of Income: Social Security Benefits:
1. Low income individuals exclude all Social Security benefits from gross income.
2. High-income individuals exclude only a portion of their benefits (up to a maximum of 85% of the benefits are taxed).
3. Taxpayers who are neither low income or high incom
Types of Income: Imputed Income:
1. Indirect Economic benefit
2. Certain employee discounts or low interest loans generate income
3. The amount of imputed income is the difference between the amount of the loan multiplied by an applicable federal interest rate and the amount of interest
Types of Income: More Imputed Income:
5. Certain employee discounts or low interest loans generate income.
6. Below-Market Rate Loans - The amount of imputed income is the difference between the amount of the loan multiplied by an applicable federal interest rate and the amount of interest th
Types of Income: Discharge of Indebtedness:
1. When a taxpayer's debt is forgiven by a lender, the taxpayer must include the amount of debt relief in gross income
2. To provide tax relief for insolvent taxpayers�tax-payers with liabilities, including tax liabilities, exceeding their assets�a discha
Exclusion Provisions: Congress allows most exclusions and deferrals for two primary reasons:
1. Yo subsidize or encourage particular activities or
2. To be fair to taxpayers (such as mitigating the inequity of double taxation)
Common Exclusions: Municipal interest:
1. Bonds issued by city, county, state, Puerto Rico and Guam governments located in the United States, and this exclusion is generally recognized as a subsidy to state and local governments
2. NOTE: This exclusion does not include bonds issued by US, exam
Common Exclusions: Gains on Sale of Personal Residence:
1. Can exclude up to $250,000 ($500,000 if MFJ) of realized gain on the sale of their personal residence
2. Must meet two tests:
2a. Ownership Test
2b. Use Test
Common Exclusions: Gains on Sale of Personal Residence: Ownership Test:
Tax payer must have owned the residence for a total of two or more years during a 5 year period ending on the date of the sale
Common Exclusions: Gains on Sale of Personal Residence: Use Test:
Tax payer must have used the property as principal residence for a total of 2 or more years during the 5 year period
Common Exclusions: Fringe benefits:
1. The value of these benefits is included in the employee's gross income as compensation for services
2. Certain fringe benefits, called "qualifying" fringe benefits, are excluded from gross income
Common Exclusions: Fringe benefits: Common Qualifying Fringe Benefits:
1. Medical Insurance Coverage
2. Dental Health Insurance Coverage
3. Life Insurance Coverage
4. De Minimis (Small) Benefits
Exclusion Provisions: Education- Related Exclusions:
As an incentive for taxpayers to participate in higher education, Congress excludes certain types of income if the funds are used for higher education
Exclusion Provisions: Education- Related Exclusions: Scholarships:
1. Students seeking a college degree can exclude scholarships that pay for required tuition, fees, books, and supplies
2. Excess scholarship amounts are fully taxable
3. Exclusion applies only if the recipient is not required to perform services in exchan
Exclusion Provisions: Other Educational Subsidies:
1. Taxpayers are allowed to exclude from gross income earnings on investments in qualified education plans such as 529 plans and Coverdell education savings accounts as long as they use the earnings to pay for qualifying educational expenditures
2. Taxpay
Exclusion Provisions: Exclusions to mitigate double taxation:
Congress provides certain exclusions to eliminate the potential double tax that may arise for Gift and Inheritances
Exclusion Provisions: Exclusions to mitigate double taxation: Gifts and Inheritances:
1. Individuals may transfer property to other taxpayers without receiving or expecting to receive value in return
2. If the transferor is alive at the time of the transfer, the property transfer is called a gift
3. If the property is transferred from the
Exclusion Provisions: Life Insurance Proceeds:
1. Similar to inheritances
2. If the policy holder dies, the beneficiary receives the death benefit proceeds. The decedent is generally subject to estate taxation on the amount of the insurance proceeds
3. To avoid potential double taxation on the life in
Exclusion Provisions: Foreign Earned Income:
U.S. citizens are subject to tax on all income whether it is generated in the US or in foreign countries
Exclusion Provisions: Foreign Earned Income: To provide relief from double taxation IRC allows for the foreign-earned income exclusion:
1. A maximum of $99,200 (2014) of foreign earned income can be excluded from gross income for qualifying individuals
2. To be eligible for the foreign earned income exclusion, the taxpayer must live in the foreign country for 330 days in a consecutive 12-
Exclusion Provisions: Sickness and Injury- Related Exclusions:
1. Tax laws provide several exclusion provisions for taxpayers who are sick or injured
2. Payments for sickness or injury should not be taxable to reflect an inability to pay the tax and facilitate recovery
Exclusion Provisions: Workers' Compensation:
1. Payments from workers' compensation plans are excluded from gross income
2. Payments received as compensation for a physical injury are excluded from gross income, but punitive damages are included in gross income
Exclusion Provisions: Payments Associated with Personal Injury:
1. Tax laws specify that any payments on account of a physical injury or sickness are nontaxable
2. Punitive damages are fully taxable
3. In general, all other awards (those that do not relate to physical injury or sickness or are payments for the medical
Exclusion Provisions: Health care reimbursement:
Reimbursements by health and accident insurance policies for medical expenses paid by the taxpayer are excluded from gross income
Exclusion Provisions: Disability insurance:
1. Also called wage replacement insurance
2. Pays the insured individual for wages lost when the individual misses work due to injury or disability
3. If an individual purchases disability insurance directly, the cost of the policy is not deductible, but
Exclusion Provisions: Deferral Provisions:
Allow taxpayers to defer (but not permanently exclude) the recognition of certain types of realized income
Exclusion Provisions: Deferral Provisions: Transactions generating deferred income include:
1. Installment sales
2. Like-kind exchanges
3. Involuntary conversions, and
4. Contributions to non-Roth qualified retirement accounts
Gross income:
Realized income reduced for any excluded or deferred income
Realization principle:
The proposition that income only exists when there is a transaction with another party resulting in a measurable change in property rights
All-inclusive income concept:
A definition of income that says that gross income means all income from whatever source derived
Barter clubs:
Organizations that facilitate the exchange of rights to goods and services between members
Wherewithal to pay:
The ability or resources to pay taxes due from a particular transaction
Return of capital:
The portion of proceeds from a sale (or distribution) representing a return of the original cost of the underlying property
Tax basis:
The amount of a taxpayer's unrecovered cost of or investment in an asset
Tax benefit rule definition:
Holds that a refund of an amount deducted in a previous period is only included in income to the extent that the deduction reduced taxable income
Accrual method:
A method of accounting that generally recognizes income in the period earned and recognizes deductions in the period that liabilities are incurred
Cash method:
The method of accounting that recognizes income in the period in which cash, property, or services are received and recognizes deductions in the period paid
Constructive receipt doctrine:
The judicial doctrine that provides that a taxpayer must recognize income when it is actually or constructively received. Constructive receipt is deemed to have occurred if the income has been credited to the taxpayer's account or if the income is uncondi
Claim of right doctrine:
Judicial doctrine that states that income has been realized if a taxpayer receives income and there are no restrictions on the taxpayer's use of the income (for example, the taxpayer does not have an obligation to repay the amount)
Assignment of income doctrine:
The judicial doctrine holding that earned income is taxed to the taxpayer providing the service, and that income from property is taxed to the individual who owns the property when the income accrues
Community property systems:
Systems in which state laws dictate how the income and property is legally shared between a husband and a wife
Earned income:
Compensation and other forms of income received for providing goods or services in the ordinary course of business
Unearned income:
Income from property that accrues as time passes without effort on the part of the owner of the property
Flow-through entities:
Legal entities like partnerships, limited liability companies, and S corporations that do not pay income tax. Income and losses from flow-through entities are allocated to their owners
Alimony:
A support payment of cash made to a former spouse. The payment must be made under a written separation agreement or divorce decree that does not designate the payment as something other than alimony, the payment must be made when the spouses do not live t
Imputed income:
Income from an economic benefit the taxpayer receives indirectly rather than directly. The amount of the income is based on comparable alternatives
Discharge of indebtedness:
Debt forgiveness
Nonrecognition provisions:
Tax laws that allow taxpayers to permanently exclude income from taxation or to defer recognizing realized income until a subsequent period
Municipal bond:
The common name for state and local government debt
Fringe benefits:
Noncash benefit provided to an employee as a form of compensation. As a general rule, fringe benefits are taxable. However, certain fringe benefits are excluded from gross income
Gift:
A transfer of property where no, or inadequate, consideration is paid for the property
Inheritance:
A transfer of property when the owner is deceased (the transfer is made by the decedent's estate)
Disability insurance:
Sometimes called sick pay or wage replacement insurance. It pays the insured for wages lost due to injury or disability
Installment sale:
A sale for which the taxpayer receives payment in more than one period