Gross Income
-taxpayers report realized and recognized income on their tax returns for the year
-income that is excluded or deferred is not included in gross income
definition of gross income for tax purposes
gross income means all income from whatever source derived"
"includes income realized in any form, whether in money, property, or services
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Taxpayers recognize gross income when:
1. they receive an economic benefit
2. they realize the income, and
3. the tax law does not provide for exclusion or deferral
economic benefit
borrowed funds represent a liability, not gross income
realization principle
-taxpayer engages in a transaction with another party
-transaction results in a measurable change in property rights
recognition
realized income is assumed to be recognized absent a deferral or exclusion provision
Other income concepts
-return of capital principle (does not represent an economic benefit)
-recovery of amounts previously deducted
return of capital principle
-the cost of an asset is called tax basis
-return on capital means the tax basis is excluded when calculating realized income
-gain from the sale or disposition of an asset is included in realized income
recovery of amounts previously deducted
-individuals typically claim deductions in the year paid
-deductions may sometimes be reimbursed or refunded in a subsequent year
-tax benefit rule
tax benefit rule
refunds of expenditures deducted in a prior year are included in gross income to the extent that the refund reduced taxes in year of the deduction
when to recognize income?
-individual taxpayers file tax returns for a calendar-year period
-corporations often use a fiscal year end
-the method of accounting generally determines the calendar year in which realized income is recognized and included in gross income
accounting methods
corporation: accrual method
individuals: cash method
constructive receipt
-taxpayer must realize and recognize income when it is actually or constructively received
-deemed to occur when the income is credited to the taxpayer's account
who recognizes the income?
-question arises when an income-shifting strategy is involved
-assignment of income
-community property systems
Assignment of income
-the assignment of income doctrine hold that the taxpayer who earns income from services must recognize the income
-income from property such as dividends and interest is taxable to the person who actually owns the income-producing property
-to shift inco
community property systems
-the state laws of 9 states implement community property systems
-the income earned from services by one spouse is treated as though it was earned equally by both spouses
-property acquired by either spouse during the marriage is usually community propert
types of income
-income from services (earned)
-income from property (unearned)
-annuities
-property dispositions
-other sources of income (other than wages or business and property)
income from services
-income from labor most common source of gross income
-generated by the efforts of tax payer
income from property
-include gain or losses from sale of property, dividends, interests, rents, royalties, and annuities
-depends on type of income and type of transaction generating income
Annuities
-an investment that pays a stream of equal payments over time
-a portion of each annuity payment as a non-taxable return of capital and the remainder as gross income
-taxpayers use the annuity exclusion ration to determine the return on of capital (non-ta
annuity exclusion ratio
amount paid/ expected value of the annuity
annuities with fixed term
expected value is number of payments times the payment amount
annuities over life
taxpayers must use IRS tables to determine expected value based on taxpayer's life expectancy
property dispositions
-taxpayers usually realize a gain or loss when disposing of an asset
-taxpayers are allowed to recover their investment in property (tax basis) before they realize any gain
formula for calculating gain (loss) from sale of an asset
sales proceeds
-selling expenses
=amount realized
-basis (investment) in property sold
=gain (loss) on sale
income from flow-through entities
-individuals may invest in various business entities
-the legal form of the business affects how the income generated by business is taxed
-if entity is flow through such as a partnership or S corp. the income deductions "flow through" to the owners of th
alimony
a transfer of cash made under written separation agreement or divorce decree
-the separation or divorce decree does not designate the payment as nonalimony and
-the payments cannot continue after death of recipient
NOT alimony
-property divisions
-child s
prizes and awards
excluded on if: made for scientific, literary, or charitable achievement and transferred to a qualified charity
social security benefits
-low income individuals exclude SS benefits from gross income
-high income individuals exclude only a portion of their benefits (up to a max of 85% of benefits are taxed)
-taxpayers who are neither low income or high income include a portion of their bene
Imputed income
-certain employee discounts or low interest loans generate income via direct benefits
-for low interest loans, the amount of imputed income is the difference between the amount of interest using the applicable federal interest rate and amount of interest
discharge of indebtedness
-when a taxpayer's debt is forgiven by a lender, the taxpayer must usually include the amount of debt relief in gross income
-to provide tax relief for insolvent taxpayers- taxpayers with liabilities, including tax liabilities, exceeding their assets- a d
exclusion provisions
congress allows certain specific types of income to be excluded or deferred
-to subsidize or encourage particular activities or to mitigate inequity
Exclusion provisions
-gain on sale of personal residence
-fringe benefits
-educational related exclusions
-other educational subsidies
-exclusions to mitigate double taxation
-foreign earned income
-sickness and injury related
Gain on sale of personal residence
-taxpayers may exclude up to $250,000 ($500,000 if married filing joint) of gain on the sale of their principal residence
-must satisfy ownership and use tests
-any excess gain generally qualifies as long term cap. gain
Fringe benefits
-the value of these benefits is included in the employee's gross income as compensation for services
-certain fringe benefits called "qualifying" fringe benefits, are excluded from gross income
-ex. medical and dental health insurance, life insurance
education related exclusions
scholarships: students seeking a college degree can exclude scholarships that pay for required tuition, fees, books, and supplies
-applies only if the recipient is not required to perform services in exchange for receiving the scholarship
other education subsidies
-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
-Taxpayers
exclusions to mitigate double taxation
gifts and inheritances:
-individuals may receive property as gifts or from a decedent's estate
-while the receipt of property is most certainly real income, the value of the gifts and inheritances are excluded from gross income because these transfers are
life insurance proceeds
-amounts received due to the death of the insured are excluded from the income of the recipient
-life insurance proceeds are typically subject to fed estate tax
-if the proceeds are paid over a period of time rather than in a lump sum, a portion of the pa
foreign earned income
-a max of $100,800 of foreign earned income can be excluded from gross income for qualifying individuals
-a max of $14,112 employer-provided foreign housing also may be excluded (but only to the extent that costs exceed $16,128)
-to be eligible for exclus
sickness and injury related exclusions
workers compensation:
-payment from workers' com. plans are excluded from gross income
-payments received as compensation for an injury are excluded, but punitive damages are included in gross income
payments associated with personal injury
-awards that relate to physical injury or sickness or payments for the medical cost of treating emotional distress are excluded from gross income
-other are fully taxable
health care reimbursement
-by health and accident insurance policies for medical expenses paid by taxpayer are excluded from gross income
disability insurance
-also called wage replacement
-pays insured individual for wages lost when misses work due to injury or disability
-if an individual purchases disability insurance directly, any benefits excluded from gross income
-if individual's employer purchases and i
Deferral provisions
-allow taxpayers to defer (but not permanently exclude) the recognition of certain types of realized income
-transactions generating deferred income include:
-installment sales
-like-kind exchanges
-involuntary conversions
-contribution to non-Roth qualif
Identify the rule dictating that on a sale of an asset a taxpayer need only include the incremental gain in gross income rather than the entire proceeds from the sale
return of capital principle
Identify the rule that determines whether a taxpayer must include in income a refund of an amount deducted in a previous year
tax benefit rule
you cannot assign earned income
true
What is true about the first payment received from a purchased annuity?
A portion of the first payment from a purchased annuity will be a return of capital depending upon the amount paid for the investment and the expected number of payments to be received
The entire annuity payment is included in gross income once the cost of the annuity is recovered.
true